PCB BANCORP (PCB) FY 2021 MD&A

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

You should read the following discussion and analysis of financial condition and results of operations together with the Consolidated Financial Statements and accompanying notes included in Item 8 of this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. 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 “Forward Looking Statements” immediately preceding Part I of this Annual Report on Form 10-K.

Critical Accounting Estimates

The Company follows 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 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. 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 the Company bases 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

The following is a summary of the more subjective and complex accounting estimates and principles affecting the financial condition and results reported in financial statements. In each area, the Company has identified the variables that management believes to be the most important in the estimation process. The Company uses the best information available to make the estimations necessary to value the related assets and liabilities in each of these areas.

Allowance for Loan Losses

Allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance for loan losses when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance for loan losses. The Company estimates the allowance for loan losses required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance for loan losses may be made for specific loans, but the entire allowance for loan losses is available for any loan that, in management’s judgment, should be charged-off. Amounts are charged-off when available information confirms that specific loans or portions thereof, are uncollectible. This methodology for determining charge-offs is consistently applied to each segment.

The Company determines a separate allowance for loan losses for each portfolio segment. The allowance for loan losses consists of specific and general reserves. Specific reserves relate to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting all amounts when due. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are to be discounted at the loan’s effective interest rate, or measured by reference to an observable market value, if one exists, or the fair value of the collateral for a collateral-dependent loan. The Company selects the measurement method on a loan-by-loan basis except that collateral-dependent loans for which foreclosure is probable are measured at the fair value of the collateral.

The Company recognizes interest income on impaired loans based on its existing methods of recognizing interest income on nonaccrual loans. Loans, for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered TDRs and classified as impaired with measurement of impairment as described above.

If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

General reserves cover non-impaired loans and are based on the Company’s historical loss rates for each portfolio segment, adjusted for the effects of qualitative factors that are likely to cause estimated credit losses as of the evaluation date to differ from the portfolio segment’s historical loss experience.

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Qualitative factors include consideration of the following: changes in lending policies and procedures; changes in economic conditions, changes in the nature and volume of the portfolio; changes in the experience, ability and depth of lending management and other relevant staff; changes in the volume and severity of past due, nonaccrual and other adversely graded loans; changes in the loan review system; changes in the value of the underlying collateral for collateral-dependent loans; concentrations of credit and the effect of other external factors such as competition and legal and regulatory requirements.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326).” The amendments in this ASU require that entities change the impairment model for most financial assets that are measured at amortized cost and certain other instruments from an incurred loss model to an expected loss model. Under this model, entities will estimate credit losses over the entire contractual term of the instrument from the date of initial recognition of that instrument. It includes financial assets such as loan receivables, held-to-maturity debt securities, net investment in leases that are not accounted for at fair value through net income, and certain off-balance sheet credit exposures. This ASU is effective for public business entities that are SEC filers for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. In 2019, the FASB amended this ASU, which delays the effective date to 2023 for certain SEC filers that are Smaller Reporting Companies, which would apply to the Company. The Company plans to adopt this ASU at the delayed effective date of January 1, 2023.

The Company has formed a committee, developed an implementation plan, and engaged a software vendor to assist the Company to build a model. The Company is in the process of completing a readiness assessment and is engaged in the implementation phase of the project. The Company is working on: (i) developing a new expected loss model with supportable assumptions; (ii) identifying data, reporting, and disclosure gaps; (iii) assessing updates to accounting and credit risk policies; and (iv) documenting new processes and controls. Based on the Company’s initial assessment of this ASU, the Company expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses which could potentially have a material impact on its consolidated financial statements as of the beginning of the first reporting period in which this ASU is effective.

Non-GAAP Measures

The Company uses certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial performance. Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position or cash flows that exclude (or include) amounts that are included in (or excluded from) the most directly comparable measure calculated, and presented in accordance with GAAP. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures and may not be comparable to non-GAAP financial measures that may be presented by other companies.

The following table presents reconciliation of allowance for loan losses to loans held-for-investment, excluding SBA PPP loans to its most comparable GAAP measure. The Company believes that this non-GAAP measure enhances comparability to prior periods in which there were no SBA PPP loans and provides supplemental information regarding the Company’s credit quality trend.

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Five-Year Summary of Selected Financial Data

The following table presents certain selected financial data as of the dates or for the periods indicated:

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(1)    Shareholders' equity divided by common shares outstanding

(2)    Dividends declared per common share divided by basic earnings per common share.

(3)    Noninterest expenses divided by the sum of net interest income and noninterest income.

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

(5)    Total loans include both loans held-for-sale and loans held-for-investment, net of unearned loan costs (fees).

(6)    Nonperforming assets include nonperforming loans (nonaccrual loans plus loans past due 90 days or more and still accruing) and other real estate owned.

(7)    This ratio is not presented in accordance with GAAP. See "Non-GAAP measure" for reconciliation of this measure to its most comparable GAAP measure.

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Executive Summary

Financial Highlights

•Net income was $40.1 million for the year ended December 31, 2021, an increase of $23.9 million, or 147.9%, from $16.2 million for the year ended December 31, 2020;

◦Provision (reversal) for loan losses was $(4.6) million, $13.2 million and $4.2 million for the years ended December 31, 2021, 2020 and 2019, respectively.

◦Diluted earnings per common share was $2.62, $1.04 and $1.49 for the years ended December 31, 2021, 2020 and 2019, respectively.

◦Net interest margin was 3.83%, 3.53% and 4.11% for the years ended December 31, 2021, 2020 and 2019, respectively.

•Total assets were $2.15 billion at December 31, 2021, an increase of $226.9 million, or 11.8%, from $1.92 billion at December 31, 2020;

•Loans held-for-investment, net of deferred costs (fees), were $1.73 billion at December 31, 2021, an increase of $148.6 million, or 9.4%, from $1.58 billion at December 31, 2020. Excluding SBA PPP loans, loans held-for-investment were $1.67 billion at December 31, 2021, an increase of $219.0 million, or 15.1%, from $1.45 billion at December 31, 2020;

◦SBA PPP loans were $65.3 million and $135.7 million at December 31, 2021 and 2020, respectively.

◦Loans with modifications related to COVID-19 were none and $36.1 million at December 31, 2021 and 2020, respectively.

•Total deposits were $1.87 billion at December 31, 2021, an increase of $272.3 million, or 17.1%, from $1.59 billion at December 31, 2020;

•BOLI of $29.3 million was purchased during the year ended December 31, 2021; and

•The Company declared and paid cash dividends of $0.44, $0.40, and $0.25 per common share for the years ended December 31, 2021, 2020 and 2019, respectively.

The increase in net income for the year ended December 31, 2021 compared with the year ended December 31, 2020 was primarily due to increases in net interest income and noninterest income and the reversal for loan losses. Net interest income increased primarily due to a decrease in cost of interest-bearing liabilities and an increase in average earning assets. Noninterest income increased primarily due to an increase in gain on sale of SBA loans. Reversal for loan losses was primarily due to a decrease in qualitative adjustment factor allocations related to economic implications of the COVID-19 pandemic during the year ended December 31, 2021.

The decrease in net income for the year ended December 31, 2020 compared with the year ended December 31, 2019 was primarily due to an increase in provision for loan losses and a decrease in net interest income. Provision for loan losses increased primarily due to the increase in risks associated with economic and business conditions, as well an increases in special mention and substandard loans, as a result of the COVID-19 pandemic, and net interest income decreased primarily due to the lower market rates during the year ended December 31, 2020.

The increase in total assets for the year ended December 31, 2021 was primarily due to increases in loans held-for-investment and loans held-for-sale and the BOLI purchase of $29.3 million. Loans held-for-investment increased primarily due to the increased commercial property and residential property loan production. Loans held-for-sale increased primarily due to the increased SBA loan production.

The Company is committed to making corporate decisions that directly benefit its shareholders, and during the year ended December 31, 2021, increased its dividend per common share by $0.04, or 10.0%, to $0.44 from $0.40 for the year ended December 31, 2020. During the year ended December 31, 2021, the Company also repurchased 680,269 shares of common stock, totaling $10.9 million. Overall, the Company returned 43.7% of its earnings to common shareholders through dividends and common share repurchases during the year ended December 31, 2021.

COVID-19 Pandemic

The ongoing COVID-19 pandemic, and governmental and societal responses thereto, have had a severe impact on global economic and market conditions. The U.S. government has enacted a number of monetary and fiscal policies to provide fiscal stimulus and relief in order to mitigate the impact of the COVID-19 pandemic. However, the COVID-19 pandemic continues to be a challenge to public health, including the emergence of new variants, and impact global economic and market conditions, including global supply chain disruptions and high inflation.

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Since the beginning of the crisis, the Company has taken a number of steps to protect the safety of its employees and to support its customers. The Company has enabled its staff to work remotely and established safety measures within its bank premises and branches for both employees and customers. In order to support its customers, the Company has been in close contact with them, assessing the level of impact on their businesses, and putting a process in place to evaluate each client’s specific situation and provide relief programs where appropriate, including SBA PPP loans and loan modifications related to the COVID-19 pandemic.

In addition, the Company has been monitoring its liquidity and capital closely. As of December 31, 2021, the Company maintained $203.3 million, or 9.5% of total assets, of cash and cash equivalents and $610.4 million, or 28.4% of total assets, of available borrowing capacity. All regulatory capital ratios were also well above the regulatory well-capitalized requirements as of December 31, 2021.

At this time, the Company cannot estimate the long term impact of the COVID-19 pandemic, but these conditions are expected to continue to impact its business, results of operations, and financial condition negatively.

Network and Data Incident

On August 30, 2021, the Bank identified unusual activity on its network. The Bank responded promptly to disable the activity, investigate its source and monitor the Bank’s network. The Bank subsequently became aware of claims that it had been the target of a ransomware attack. On September 7, 2021, the Bank determined that an external actor had illegally accessed and/or acquired certain data on its network. The Bank has been working with third-party forensic investigators to understand the nature and scope of the incident and determine what information may have been accessed and/or acquired and who may have been impacted. The investigation revealed that this incident impacted certain files containing certain Bank customer information. Some of these files contained documents related to loan applications, such as tax returns, Form W-2 information of their employees, and payroll records. The Bank has notified all individuals identified as impacted, consistent with applicable laws. All impacted individuals were offered free Equifax Complete Premier credit monitoring and identify theft protection services. The Bank has notified law enforcement and appropriate authorities of the incident.

On December 16, 2021, a complaint based on the incident was filed in the Los Angeles County Superior Court seeking damages, injunctive relief, and equitable relief. The Bank expresses no opinion on the merits of the Matter and intends to answer, respond, and/or otherwise vigorously defend itself from the claims and causes of action asserted in the complaint to the fullest extent permitted by applicable law. Those defenses will be based in part on the fact that the Bank has implemented security procedures, practices, and a robust information security program pursuant to guidance from financial regulators. Please see Part I Item 3 for more information about the litigation.

The Company continues to monitor and evaluate the data incident for its magnitude and concomitant financial, legal or reputational consequences. To date, such consequences are not material, however the data incident is still recent and notices to affected individuals only recently began and the lawsuit mentioned above is in its very early stages. During the year ended December 31, 2021, expenses associated with the data incident, all of which are included in Other Expense in Consolidated Statements of Income (Unaudited), totaled $100 thousand, which represents the retention amount on its insurance claims. The Company anticipates additional expenses will be incurred in future periods; however, the Company does have a cyber-liability insurance policy that should provide insurance coverage for this incident.

During its most recent review of disclosure controls and procedures, the Company considered the data incident and concluded that its disclosure controls and procedures were effective. Nevertheless, the Company continues to enhance and update its disclosure controls and procedures, including as part of its efforts to enhance its cybersecurity safeguards and measures. With respect to the data incident, upon discovery the Bank engaged experienced outside counsel and continues to work with its experienced third-party forensics firm to investigate and remediate the matter. The Board of Directors was kept apprised of, and a director with experience in data security participated in, the investigation and remediation efforts. As a result of this incident and based on information known at this date, the Company determined that its disclosure controls and procedures were effective and the data incident did not materially affect, nor was it reasonably likely to affect, the Company’s internal control over financial reporting.

Result of Operations

Net Interest Income

A principal component of the Company’s earnings is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and borrowed funds. Net interest income expressed as a percentage of average interest-earning assets is referred to as the net interest margin. The net interest spread is the yield on average interest-earning assets less the cost of average interest-bearing liabilities. Net interest income is affected by changes in the balances of interest-earning assets and interest-bearing liabilities and changes in the yields earned on interest-earning assets and the rates paid on interest-bearing liabilities.

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The following table presents interest income, average interest-earning assets, interest expense, average interest-bearing liabilities, and their correspondent yields and costs expressed both in dollars and rates for the periods indicated:

(1)    Average balance includes both loans held-for-sale and loans held-for-investment, as well as nonaccrual loans. Net amortization of deferred loan fees (cost) of $6.1 million, $2.9 million and $452 thousand, respectively, and net accretion of discount on loans of $3.5 million, $3.3 million and $4.0 million, respectively, are included in the interest income for the years ended December 31, 2021, 2020 and 2019, respectively.

(2)    The yield on municipal bonds has not been computed on a tax-equivalent basis.

(3)    Net interest spread is calculated by subtracting average rate on interest-bearing liabilities from average yield on interest-earning assets.

(4)    Net interest margin is calculated by dividing net interest income by average interest-earning assets.

(5)    Cost of funds is calculated by dividing interest expense on deposits by the sum of interest-bearing and noninterest-bearing demand deposits.

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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.

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

The following table presents the components of net interest income for the periods indicated:

Net interest income increased primarily due to a 7.2% increase in average balance of interest-earning assets and a 74 basis point decrease in average cost of interest-bearing liabilities, partially offset by a 20 basis point decrease in average yield on interest-earning assets and a 10.9% decrease in average balance of interest-bearing liabilities. The increase in average balance of interest-earning assets was primarily due to growth in the loan and investment securities, supported by deposit growth. The decreases in average yield on interest-earning assets and average cost of interest-bearing liabilities were primarily due to the lower market rates during the year ended December 31, 2021.

Interest and fees on loans increased primarily due to a 10.4% increase in average balance, partially offset by a 31 basis point decrease in average yield. The increase in average balance was primarily due to an increase in commercial property loans, partially offset by decreases in commercial term and SBA PPP loans. The decrease in average yield was primarily due to the lower market rates, partially offset by increases in net amortization of deferred fees on SBA PPP loans and net accretion of discount.

Interest on investment securities decreased primarily due to a 49 basis point decrease in average yield, partially offset by a 6.3% increase in average balance. The decrease in average yield was primarily due to new investment securities purchased at lower market rates. The Company purchased $47.3 million and $39.4 million, respectively, of investment securities during the years ended December 31, 2021 and 2020. For the years ended December 31, 2021 and 2020, average yield on total investment securities was 1.24% and 1.73%, respectively.

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Interest income on other interest-earning assets decreased primarily due to a 12 basis point decrease in average yield and a 15.8% decrease in average balance. The decrease in average yield was primarily due to the lower market rates. The decrease in average balance was primarily due to increases in loans and investment securities. For the years ended December 31, 2021 and 2020, yield on total other interest-earning assets was 0.39% and 0.51%, respectively.

Interest expense on deposits decreased primarily due to a 6.1% decrease in average balance of interest-bearing deposits and a 79 basis point decrease in average cost of interest-bearing deposits. The decrease in average balance was primarily due to a decrease in time deposits, partially offset by increases in savings, NOW and money market accounts. The decrease in average cost was primarily due to the lower market rates. For the years ended December 31, 2021 and 2020, average cost on total interest-bearing deposits was 0.40% and 1.19%, respectively.

Interest expense on other borrowings decreased primarily due to a 66.8% decrease in average balance, partially offset by a 28 basis point increase in average cost. The increase in average cost was primarily due to matured borrowings with lower interest rates during the year ended December 31, 2021. Matured FHLB advances totaled $70.0 million with a weighted-average rate of 0.47% for the year ended December 31, 2021.

Year Ended December 31, 2020 Compared to Year Ended December 31, 2019

The following table presents the components of net interest income for the periods indicated:

Net interest income decreased primarily due to a 128 basis point decrease in average yield on interest-earning assets and a 3.2% increase in average balance of interest-bearing liabilities, partially offset by a 11.8% increase in average balance of interest-earning assets and a 94 basis point decrease in average cost of interest-bearing liabilities. The increase in average balance of interest-earning assets was primarily due to growth in the loan and other interest-earning assets, supported by deposit growth. The decreases in average yield on interest-earning assets and average cost of interest-bearing liabilities were primarily due to the lower market rates during the year ended December 31, 2020.

Interest and fees on loans decreased primarily due to a 123 basis point decrease in average yield, partially offset by an 11.4% increase in average balance. The decrease in average yield was primarily due to the lower market rates, the 1% interest rate on SBA PPP loans, and a decrease in net accretion of discount, partially offset by an increase in net amortization of deferred fees on SBA PPP loans. The increase in average balance was primarily due to the SBA PPP loan production as well as an increase in commercial property loans.

Interest on investment securities decreased primarily due to a 23.7% decrease in average balance and a 73 basis point decrease in average yield. The decrease in average balance was primarily due to a sale of investment securities of $32.8 million in December 2019, which lead to a lower average balance in 2020, partially offset by new investment securities purchased in 2020. The decrease in average yield was primarily due to new investment securities purchased at lower market rates, as well as the sales of securities available-for-sale in December 2019 with a weighted-average book yield of 3.02%. The Company purchased $39.4 million and $14.1 million, respectively, of investment securities during the years ended December 31, 2020 and 2019. For the years ended December 31, 2020 and 2019, average yield on total investment securities was 1.73% and 2.46%, respectively.

Interest income on other interest-earning assets decreased primarily due to a 195 basis point decrease in average yield, partially offset by a 58.0% increase in average balance. The decrease in average yield was primarily due to the lower market rates. The increase in average balance was primarily due to increases in deposits and other borrowings as the Company maintains most of its cash at the Federal Reserve Bank account. For the years ended December 31, 2020 and 2019, yield on total other interest-earning assets was 0.51% and 2.46%, respectively.

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Interest expense on deposits decreased primarily due to a 2.9% decrease in average balance of interest-bearing deposits and a 90 basis point decrease in average cost of interest-bearing deposits. The decrease in average balance was primarily due to a decrease in time deposits, partially offset by increases in savings, NOW and money market accounts. The decrease in average cost was primarily due to the lower market rates. For the years ended December 31, 2020 and 2019, average cost on total interest-bearing deposits was 1.19% and 2.09%, respectively.

Interest expense on other borrowings increased primarily due to a 271.5% increase in average balance, partially offset by a 121 basis point decrease in average cost. The decrease in average cost was primarily due to the lower market rates. The increase in average balance was primarily due to the Company’s liquidity management plan in response to the COVID-19 pandemic.

Provision (reversal) for Loan Losses

Provision (reversal) for loan losses was $(4.6) million, $13.2 million and $4.2 million for the years ended December 31, 2021, 2020 and 2019. The reversal for loan losses for the year ended December 31, 2021 was primarily due to a decrease in qualitative adjustment factor allocations related to economic implications of the COVID-19 pandemic. The increase for the year ended December 31, 2020 in provision for loan losses was primarily due to the increase in risks associated with economic and business conditions and uncertainty, as well as the increases in special mention and classified loans, as a result of the COVID-19 pandemic.

See further discussion in “Loans Held-For-Investment and Allowance for Loan Losses.”

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Noninterest Income

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

The following table presents the components of noninterest income for the periods indicated:

Service charges and fees on deposits decreased primarily due to a decrease in fee-based transactions.

Loan servicing income represents fees received on loans that the Company services, net of amortization of servicing assets. The increase was primarily due to an increase in servicing income received, partially offset by an increase in amortization of servicing assets from increased prepayments of loans being serviced.

The Company purchased bank-owned life insurance of $29.3 million during November 2021. Bank-owned life insurance income represents the increase in cash surrender value of the insurance policy.

Gain on sale of loans increased primarily due to increases in sales volume and gain margin. The increase in gain margin on SBA loans was primarily due to the temporary increase of SBA guaranteed portion until September 30, 2021 under the Economic Aid Act. The Company sold SBA loans of $126.8 million with a gain of $12.8 million, residential property loans of $10.4 million with a gain of $151 thousand and certain commercial property loans of $8.6 million with a gain of $6 thousand during the year ended December 31, 2021. During the year ended December 31, 2020, the Company sold SBA loans of $89.8 million with a gain of $6.0 million and residential property loans of $51.9 million with a gain of $489 thousand.

Other income included wire and remittance fees of $596 thousand and $530 thousand, respectively, and debit card interchange fees of $306 thousand and $252 thousand, respectively, for the years ended December 31, 2021 and 2020.

Year Ended December 31, 2020 Compared to Year Ended December 31, 2019

The following table presents the components of noninterest income for the periods indicated:

Service charges and fees on deposits decreased primarily due to a decrease in fee-based transactions.

The increase was primarily due to a decrease in amortization of servicing assets from decreased prepayments of loans being serviced.

Gain on sale of loans increased primarily due to increases in sales volume and premium. The increase in premium on SBA loans was primarily due to the market condition and the increase in sale volume of residential property loans was primarily due to increased refinancing activities during the year ended December 31, 2020. The Company sold SBA loans of $89.8 million with a gain of $6.0 million and residential property loans of $51.9 million with a gain of $489 thousand during the year ended December 31, 2020. During the year ended December 31, 2019, the Company sold SBA loans of $99.6 million with a gain of $5.9 million and residential property loans of $10.1 million with a gain of $81 thousand.

The Company sold securities available-for-sale of $32.8 million during the year ended December 31, 2019, while the Company did not sell any securities for the year ended December 31, 2020.

Other income included wire and remittance fees of $529 thousand and $515 thousand, respectively, and debit card interchange fees of $252 thousand and $272 thousand, respectively, for the years ended December 31, 2020 and 2019.

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Noninterest Expense

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

The following table presents the components of noninterest expense for the periods indicated:

Salaries and employee benefits increased primarily due to increases in wages, bonus accrual, and incentives tied to LPO originated SBA loan sales, partially offset by decreases in vacation and stock compensation expense. The number of full-time equivalent employees averaged 247.9 for the year ended December 31, 2021 compared to 251.8 for the year ended December 31, 2020.

Occupancy and equipment expense decreased primarily due to a decrease in depreciation, partially offset by an increase in equipment maintenance expense.

Professional fees decreased primarily due to a decrease in expense related to enhancement of the Bank's controls and processes on BSA/AML compliance programs, partially offset by an increase in audit fees.

Marketing and business promotion expense increased primarily due to increased marketing activities and advertisement.

Data processing expense increased primarily due to an increase in processing costs from a greater number of accounts and transactions.

Director fees and expenses decreased primarily due to a severance payment of $45 thousand for a former director during the year ended December 31, 2020.

Regulatory assessment expense decreased primarily due to a decrease in assessment rate, partially offset by an increase in balance sheet.

Other expense decreased primarily due to a decrease in other loan related legal expense, partially offset by an increase in armed guard expenses. Other loan related legal expenses were $302 thousand and $426 thousand, respectively, and armed guard expense of $546 thousand and $506 thousand, respectively, for the years ended December 31, 2021 and 2020, respectively. Other expenses also included office expenses of $1.4 million and $1.4 million, respectively, and reversal for unfunded loan commitments was $24 thousand and $63 thousand, respectively for the years ended December 31, 2021 and 2020, respectively.

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Year Ended December 31, 2020 Compared to Year Ended December 31, 2019

The following table presents the components of noninterest expense for the periods indicated:

Salaries and employee benefits increased primarily due to increases in wages, other employee benefits and vacation accrual, partially offset by a direct loan origination cost of $1.1 million related to SBA PPP loan production and a decrease in bonus accrual. The number of full-time equivalent employees averaged 251.8 for the year ended December 31, 2020 compared to 250.2 for the year ended December 31, 2019.

Occupancy and equipment expense increased primarily due to increases in rent and equipment maintenance expenses.

Professional fees decreased primarily due to a decrease in expense related to enhancement of the Bank's controls and processes on BSA/AML compliance programs. The consent order with the FDIC and CDFPI related to the BSA/AML compliance was terminated on September 30, 2020.

Marketing and business promotion expense decreased primarily due to fewer marketing activities related to the COVID-19 pandemic for the year ended December 31, 2020.

Data processing expense increased primarily due to an increase in processing costs from a greater number of accounts and transactions.

Director fees and expenses decreased primarily due to the Company's Board of Directors decision to temporarily decrease director fees from the second quarter of 2020, partially offset by a severance payment of $45 thousand for a former director during the year ended December 31, 2020.

Regulatory assessment expense increased primarily due to a small bank credit of $345 thousand received from the FDIC during the year ended December 31, 2019, as well as an increase in balance sheet.

Other expense decreased primarily due to decreases in office expenses, provision for unfunded loan commitments, other loan related legal expenses, and armed guard expenses. Other expenses included office expenses of $1.4 million and $1.7 million, respectively, provision (reversal) for unfunded loan commitments was $(63) thousand and $162 thousand, respectively, Other loan related legal expenses were $426 thousand and $486 thousand, respectively, and armed guard expense of $506 thousand and $555 thousand, respectively, for the years ended December 31, 2020 and 2019, respectively.

Income Tax Expense

Income tax expense was $16.9 million, $6.8 million and $10.2 million, respectively, and the effective tax rate was 29.6%, 29.7% and 29.8%, respectively, for the years ended December 31, 2021, 2020 and 2019.

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Financial Condition

Investment Securities

On June 30, 2020, the Company transferred securities held-to-maturity to securities available-for-sale as a part of the Company’s liquidity management plan in response to the COVID-19 pandemic. Management determined that its securities held-to-maturity no longer adhere to the Company’s current liquidity management plan and could be sold to potentially improve the Company’s liquidity position. Accordingly, the Company was no longer able to assert that it had the intent to hold these securities until maturity and the Company’s ability to assert that it has the intent and ability to hold to maturity debt securities will be limited for up to two years from the date of transfer. The Company transferred all securities held-to-maturity of $18.8 million to securities available-for-sale, which resulted in a pre-tax increase to accumulated other comprehensive income of $787 thousand.

The following table presents the amortized cost and fair value of the investment securities portfolio as of the dates indicated:

Total carrying value of investment securities were $123.2 million at December 31, 2021, an increase of $2.7 million, or 2.2%, from $120.5 million at December 31, 2020. The increase was primarily due to purchases of $47.3 million, partially offset by principal paydowns and calls of $41.1 million, a decrease in fair value of securities available-for-sale of $2.6 million and net premium amortization of $1.0 million.

All individual securities in a continuous unrealized loss position for 12 months or more as of December 31, 2021 and December 31, 2020 had an investment grade rating upon purchase. The issuers of these securities have not established any cause for default on these securities and various rating agencies have reaffirmed their long-term investment grade status as of December 31, 2021 and 2020. These securities have fluctuated in value since their purchase dates as market interest rates fluctuated. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell before the recovery of its amortized cost basis. The Company determined that the investment securities with unrealized losses for twelve months or more are not other-than-temporary impaired, and, therefore, no impairment was recognized at December 31, 2021 and 2020.

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The following table presents the contractual maturity schedule for securities, at amortized cost, and their weighted-average yields as of December 31, 2021. Weighted-average yields are based upon the amortized cost of securities and are calculated using the interest method which takes into consideration of premium amortization and discount accretion. Weighted-average yields on tax-exempt debt securities exclude the federal income tax benefit.

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Loans Held-For-Investment and Allowance for Loan Losses

The following table presents the composition of the Company’s loans held-for-investment as of the dates indicated:

Loans held-for-investment were $1.73 billion at December 31, 2021, an increase of $148.6 million, or 9.4%, from $1.58 billion at December 31, 2020. The increase was primarily due to new funding of $619.7 million and advances of $118.9 million, partially offset by paydowns and payoffs of $581.0 million, transfers to loans held-for-sale of $8.8 million and charge-offs of $227 thousand. The increase for the year ended December 31, 2021 was primarily due to increases in commercial property and residential property loans, partially offset by decreases in SBA PPP and commercial term loans. As of December 31, 2021, the Company recognized $181.8 million in forgiveness.

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The following table shows the contractual maturities of loans held-for-investment and the distribution between fixed and floating interest rate loans at December 31, 2021:

SBA Paycheck Protection Program

The following table presents a summary of SBA PPP loans as of the dates indicated:

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Loan Modifications Related to the COVID-19 Pandemic

The Company started providing modifications related to the COVID-19 pandemic during the three months ended June 30, 2020. The Company had no outstanding modification since September 30, 2021. The following table presents activity in loans under modified terms related to the COVID-19 pandemic for the year ended December 31, 2021.

(1)    Termination of modifications at the request of the borrower.

The following table presents the risk categories and accrued interest receivable for loans previously modified in response to the COVID-19 pandemic, but that have reverted back to previous contractual payment terms as of December 31, 2021:

Loans that were granted modifications related to the COVID-19 pandemic in excess of 6 months, on a cumulative basis, were classified as special mention or substandard. There were no past due or nonaccrual loans that were previously modified in response to the COVID-19 pandemic, but that had reverted back to previous contractual payment terms as of December 31, 2021.

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Allowance for loan losses

The following table reflects allocation of the allowance for loan losses by loan category and the ratio of each loan category to total loans as of the dates indicated:

(1)    This ratio is not presented in accordance with GAAP. See "Non-GAAP measure" for reconciliation of this measure to its most comparable GAAP measure.

The SBA guarantee on PPP loans cannot be separated from the loan and therefore is not a separate unit of account. The Company considered the SBA guarantee in the allowance for loan losses evaluation and determined that it is not required to reserve an allowance on SBA PPP loans at December 31, 2021 and 2020.

The decrease in allowance for loan losses for the year ended December 31, 2021 was primarily due to a decrease in qualitative adjustment factor allocations related to economic implications of the COVID-19 pandemic.

The increase in allowance for loan losses for the year ended December 31, 2020 was primarily due to increased risks associated with economic and business conditions, as well as increases in special mention and substandard loans, as a result of the COVID-19 pandemic.

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The following tables present net charge-offs as a percentage to the average loan held for investment balances in each of the loan categories for the periods indicated: