RBB Bancorp (RBB) FY 2021 MD&A

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

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of the Company’s audited consolidated financial statements are based upon its audited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these audited consolidated financial statements 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 differ from these estimates under different assumptions or conditions.

The following is a summary of the more judgmental and complex accounting estimates and principles. In each area, we have identified the variables we believe are most important in our estimation process. We utilize information available to us to make the necessary estimates to value the related assets and liabilities. Actual performance that differs from our estimates and future changes in the key variables and information could change future valuations and impact the results of operations.

Our significant accounting policies are described in greater detail in our 2021 audited financial statements included in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K, specifically in “Note 2 – Summary of Significant Accounting Policies” which are essential to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

For the year 2021, we reported net earnings of $56.9 million, compared with $32.9 million for the year 2020. This represented an increase of $24.0 million, or 72.8%, over the prior year. The increase in net earnings reflected a $19.6 million increase in net interest income, a $4.7 million increase in non-interest income, $7.9 million decrease in the provision for loan losses and a $1.3 million  decrease in non-interest expenses, which was partially offset by a $9.5 million increase in income tax expense.

At December 31, 2021, total assets were $4.2 billion, an increase of $878.1 million, or 26.2%, from total assets of $3.4 billion at December 31, 2020. Interest-earning assets were $4.0 billion as of December 31, 2021, an increase of $831.3 million, or 26.3%, compared to $3.2 billion at December 31, 2020. The increase in interest-earning assets was primarily due to net HFI loan growth of $224.6 million and investment securities growth of $156.5 million, partially offset by a decrease of $44.0 million in mortgage loans available for sale.

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At December 31, 2021, available for sale (“AFS”) investment securities totaled $368.3 million inclusive of a pre-tax net unrealized loss of $2.4 million, compared to $210.9 million inclusive of a pre-tax net unrealized gain of $1.6 million at December 31, 2020. At December 31, 2021, held to maturity (“HTM”) investment securities totaled $6.3 million, compared to $7.2 million as of December 31, 2020.

Net loans and leases (held for investment, net of deferred fees, discounts, and the allowance for loan losses) were $2.9 billion at December 31, 2021, compared to $2.7 billion at December 31, 2020. Net loans and leases increased $221.0 million, or 8.3%, from December 31, 2020. The increase in net loans was due to organic growth.  The increase in net loans included approximately $244.4 million in CRE loans, $116.4 million in construction loans and $26.7 million in other loans, partially offset by a $119.8 million decrease in SFR mortgage loans, $21.4 million in C&I loans and $21.7 million in SBA loans.

Total deposits were $3.4 billion at December 31, 2021, an increase of $750.4 million, or 28.5%, compared to $2.6 billion at December 31, 2020. The increase is due to an increase of $870.8 million in non-maturity deposits, partially offset by a net decrease of $120.4 million from time  deposits, and the remainder from organic growth.

Noninterest-bearing deposits were $1.3 billion at December 31, 2021, an increase of $674.3 million, or 109.2%, from $617.2 million at December 31, 2020.  At December 31, 2021, noninterest-bearing deposits were 38.1% of total deposits, compared to 23.4% at December 31, 2020.

Our average cost of total deposits was 0.40% for the year 2021, compared to 1.01% for 2020. The decrease is due to a 73 basis point decrease in the average rate paid on interest bearing deposits. Borrowings, consisting of FHLB long-term advances, long-term debt and subordinated debt, increased $68.8 million to $337.5 million as of December 31, 2021 compared to $268.7 million as of December 31, 2020. The Company had no short-term FHLB advances, and $150.0 million in long-term advances at December 31, 2021 and at December 31, 2020.

The allowance for loan losses was $32.9 million at December 31, 2021, an increase of $3.6 million or 12.2%, from $29.3 million at December 31, 2020.  During 2021, there was a $4.0 million provision for loan losses compared to $11.8 million for 2020. The ALLL to HFI loans and leases outstanding was 1.12% and 1.08% as of December 31, 2021 and December 31, 2020, respectively.

Shareholders’ equity increased $38.2 million, or 8.9%, to $466.7 million as of December 31, 2021 from $428.5 million at December 31, 2020.  The increase during 2021 was primarily due to $56.9 million of net income, less $9.9 million of common dividends paid and $10.5 million from the repurchase of common stock.

Our capital ratios under the Basel III capital framework regulatory standards remain well capitalized. As of December 31, 2021, the Company’s Tier 1 leverage capital ratio was 10.21%, common equity Tier 1 ratio was 14.86%, Tier 1 risk-based capital ratio totaled 15.40%, and total risk-based capital ratio was 23.15%.

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ANALYSIS OF THE RESULTS OF OPERATIONS

Financial Performance

Results of Operations—Comparison of Results of Operations for the Years Ended December 31, 2021 to December 31, 2020

Net Interest Income/Average Balance Sheet

In 2021, we generated fully-taxable equivalent net interest income of $124.4 million, an increase of $19.6 million, or 18.7%, from the net interest income produced in 2020. This increase was largely due to a 20.7% increase in the average balance of interest-earning assets, in part due to organic loan growth, partially offset by an 6 basis point decrease in the net interest margin. For the years ended December 31, 2021 and 2020 our reported net interest margin was 3.46% and 3.52%, respectively. Our net interest margin benefits from discount accretion on our purchased loan portfolios.

Interest Income. Total fully-taxable equivalent interest income was $147.1 million in 2021 compared to $139.2 million in 2020. The $8.0 million, or 5.7%, increase in total interest income was mainly due to increases in the average balance of total loans of $180.9 million, average balance of securities of $144.1 million, and average balance of Federal funds sold, cash equivalents and other investments of $292.2 million. This was partially offset by a decrease in the average total loan yield of 6 basis points.

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Interest and fees on loans was $141.6 million in 2021 compared to $133.9 million in 2020. The $7.7 million, or 5.7%, increase in interest income on loans was primarily due to a $180.9 million increase in the average balance of total loans outstanding, partially offset by 6 basis point decrease in the average yield on total loans. The increase in the average balance of loans outstanding was primarily due to organic growth in commercial real estate and single-family residential mortgage loans during 2021. The yield on the loan portfolio benefited from accretion income associated with purchase accounting discounts established on loans acquired in prior acquisitions. For the years 2021 and 2020, the reported yield on total loans was 5.12% and 5.18%, respectively. The impact of accretion income on our yield on total loans for the years 2021 and 2020 was to increase our reported yield on total loans by 0.03% and 0.08%, respectively.  A substantial portion of our acquired loan portfolio that is subject to discount accretion consists of commercial real estate loans and single family residential mortgages.

The table below illustrates by loan type the accretion income for the years 2021, 2020 and 2019:

Interest income from our securities portfolio increased $454,000, or 15.1%, to $3.5 million in 2021. The increase in interest income on securities was primarily due to an increased average balance of $144.1 million, or 78.8%, partially offset by a 58 basis point decrease in the average yield of securities.

Interest income on our federal funds sold, cash equivalents and other investments decreased $143,000, or 6.3%, to $2.1 million in 2021. The decrease in interest income on these earning assets was primarily due to a 64 basis point decrease in average yield of cash equivalents, partially offset by a $292.2 million increase in the average balance. The increase in the average balance resulted from pending utilization of these funds to higher yielding loans and securities.

Interest Expense. Interest expense on interest-bearing liabilities decreased $11.6 million, or 33.9%, to $22.7 million in 2021 primarily due to a 63 basis point decrease in the average rate on these liabilities plus an increase in average non-interest bearing deposits of $374.6 million, partially offset by a $216.5 million increase in the average balance of interest bearing liabilities.

Interest expense on total deposits decreased to $12.0 million in 2021. The $13.2 million, or 52.6%, decrease in interest expense on total deposits was primarily due to a 73 basis point decrease in the average rate paid on total average interest bearing deposits, partially offset by a $141.9 million increase in the average balance of interest-bearing deposits. The increase in the average balance of deposits resulted primarily from organic growth in 2021.

Interest expense on borrowings increased 17.5% from $9.2 million in 2020 to $10.8 million in 2021. This increase reflected increased average balances in long term debt. In 2021, the average rate on these liabilities was 3.34% compared to 3.70% in 2020.

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Average Balance Sheet, Interest and Yield/Rate Analysis

The principal component of our earnings is net interest income, which is the difference between the interest and fees earned on loans and investments (interest-earning assets) and the interest paid on deposits and borrowed funds (interest-bearing liabilities). Net interest margin is net interest income as a percentage of average interest-earning assets for the period. The level of interest rates and the volume and mix of interest-earning assets and interest-bearing liabilities impact net interest income and net interest margin. The net interest spread is the yield on average interest earning assets minus the cost of average interest-bearing liabilities. Net interest margin and net interest spread are included on a tax equivalent (“TE”) basis by adjusting interest income utilizing the federal statutory tax rate of 21% for 2021,  2020 and 2019. Our net interest income, interest spread, and net interest margin are sensitive to general business and economic conditions. These conditions include short-term and long-term interest rates, inflation, monetary supply, and the strength of the international, national and state economies, in general, and more specifically, the local economies in which we conduct business. Our ability to manage net interest income during changing interest rate environments will have a significant impact on our overall performance. We manage net interest income through affecting changes in the mix of interest-earning assets as well as the mix of interest-bearing liabilities, changes in the level of interest-bearing liabilities in proportion to interest-earning assets, and in the growth and maturity of earning assets. See “Analysis of Financial Condition—Capital Resources and Liquidity Management” and Item 7A Quantitative and Qualitative Disclosures about Market Risk included herein.

The following tables present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the years 2021, 2020 and 2019. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Interest income on loans includes the effects of discount accretion and net deferred loan origination costs accounted for as yield adjustments.

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Interest Rates and Operating Interest Differential

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following tables show the effect that these factors had on the interest earned on our interest-earning assets and the interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the previous period’s average rate. Similarly, the effect of rate changes is calculated by multiplying the change in average rate by the previous period’s volume. Changes which are not due solely to volume or rate have been allocated to these categories based on the respective percent changes in average volume and average rate as they compare to each other.

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Provision for Loan Losses

The provision for loan losses in 2021 was $4.0 million compared to $11.8 million in 2020. The decrease in the 2021 provision expense was primarily attributable to a decrease in COVID-19 pandemic related market effects from 2020, partially offset by increases in past due loans, substandard loans and impaired loans. Non-performing loans that increased during the year were individually analyzed, with $30,000 in 2021 and $525,000 in 2020, net addition to the allowance for loan losses.

Noninterest Income

Noninterest income increased $4.7 million, or 33.5%, to $18.7 million in 2021 from $14.0 million in 2020. The following table sets forth the major components of noninterest income for the years ended December 31, 2021, 2020 and 2019:

Service charges, fees and others. The increase in noninterest income from service charges, fees and other income was primarily from service charges on the additional transactional deposit accounts originated organically.

Gain on sale of loans. The gain on sales of loans increased $4.0 million due primarily to the increase in gains of $2.7 million in SFR mortgage loans sold and increase in gains of $1.3 million in SBA loans sold. Increases in gain on sales of loans were due to increases of $7.2 million on SBA loans sold and $92.4 million on mortgage loans held for sale.  The increase in the mortgage loan sales is attributable to the favorable change in market conditions in the secondary market.

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Loan servicing income, net of amortization. Servicing income decreased due to increased loan pre-payments in the SFR loans serviced causing a decrease in the volume of mortgage loans we are servicing. SBA loan servicing income decreased due to a decline in SBA pre-payments.

Recoveries on loans acquired in business combinations. Recoveries on loans acquired in business combinations decreased by $2,000 to $82,000 in 2021 compared to $84,000 in 2020.

Gain on derivatives.  Due to the amount of loans that were committed to be delivered to FNMA at year-end, we recorded derivatives which resulted in a gain of $46,000 in 2021 and $78,000 in 2020. In 2021 and 2020, the income from interest rate lock commitments ("IRLCs") was ($41,000) and $182,000, respectively, and was recorded as service charges, fees and other.  The income from forward mortgage loan sales commitments ("FMLSCs") was $46,000 and $78,000 in 2021 and 2020, respectively, and is reported in the income statement.  There was no IRLC and FMLSC income in 2019.

Cash surrender value income of bank owned life insurance. Cash surrender value income of bank owned life insurance (“BOLI”) increased $300,000 due to additional BOLI investment of $19.9 million in June 2021.

Gain on sales of securities, net. Gain on sales of securities, net was $210,000 in 2020 from the sale of $11.7 million securities.  There was no gain on sale of securities in 2021.

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Noninterest Expense

Noninterest expense decreased $1.3 million, or 2.2%, to $58.2 million in 2021 from $59.5 million in 2020. The following table sets forth the major components of our noninterest expense for the years ended December 31, 2021, 2020 and 2019:

Salaries and employee benefits. Salaries and employee benefits expense increased $256,000 due to normal salary increases. The number of full-time equivalent employees were 365 at December, 31, 2021, 366 at year-end 2020 and 355 at year-end 2019.  None of our employees are represented by a labor union, or governed by any collective bargaining agreements. We consider relations with our employees to be satisfactory. On a periodic basis, the human resources department will advise senior management of the following human capital management metrics: (1) open positions, (2) overtime expense, (3) staff turnover, and (4) employee headcount.

Occupancy and equipment. Occupancy and equipment expense decreased $1.0 million from 2020 to 2021 mainly due to the savings from branch closures in 2020 and in early 2021.

Data processing. Data processing expense increased $238,000 in 2021. This increase was primarily due to upgrading our infrastructure. Effective June 2019, the Company renegotiated its data processing master agreement with its vendor, under which the Company is allowed to offset future monthly data processing expenses up to approximately $2.2 million through January 2026. As of December 31, 2021, this offset benefit amounted to $1.2 million to be recognized through January 2026.

Legal and professional. Legal and professional expense increased $1.0 million in 2021 due to increases in internal control audits, professional expense associated with emerging growth company status and problem loan collections.

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Office expenses. Office expenses, comprised of communications, postage, armored car, and office supplies, decreased by $29,000 in 2021.

Marketing and business promotion. Marketing and business promotion expense increased $406,000, due to increased marketing efforts following the COVID-19 pandemic.

Insurance and regulatory assessments. Insurance and regulatory assessments expense increased by $577,000 to $1.6 million in 2021 compared to $984,000 in 2020. The FDIC insurance assessment was $949,000 in 2021 and $455,000 in 2020, an increase of $494,000. The California DFPI regulatory assessment increased by $20,000 from $163,000 for the year 2020 to $183,000 for year 2021.  The corporate insurance expenses (including directors and officers insurance and fidelity bond), was $435,000 for 2021 compared to $363,000 for 2020.

Amortization of intangibles. Amortization of intangibles totaled $1.1 million in 2021 as compared to $1.4 million for 2020. The decrease was due to continued amortization of the core deposit intangible asset, following the additional core deposit intangible asset of $491,000 recognized in connection with the 2020 PGBH acquisition.

OREO expenses. OREO expenses were $17,000 in 2021 and $35,000 in 2020. The $18,000 decrease was due to no further ongoing expenses for past OREOs.

Merger expenses. Merger expenses were $137,000 in 2021 compared to $746,000 in 2020. The 2021 expense includes expenses relating to the acquisition of the Hawaii branch.  While the 2020 expenses relate to the PGBH acquisition.

Other noninterest expenses. Other expenses decreased by $1.9 million from 2020, primarily due to the provision (benefit) for credit losses associated with unfunded commitments as of the balance sheet date of ($180,000) in 2021 compared to $558,000 in 2020. The off-balance sheet liabilities are letters of credit and other commitments to lend. The provision for off-balance sheet liabilities is a function of the volume of undisbursed loans and other loan commitments multiplied by a risk factor. Other expense increases included a $416,000 decrease in mortgage servicing rights impairment due to reversal of write-downs reflecting the decline in market rates of interest.

Income Tax Expense

Income tax expense was $24.0 million in 2021 compared to $14.5 million in 2020, an increase of $9.5 million, or 65.4%. The effective tax rate for 2021 was 29.7% and 30.6% for 2020. Income tax expense for 2021 included a $873,000 benefit for stock options exercised and a $26,000 benefit for 2020.

Net Income

Net income increased $24.0 million to $56.9 million in 2021, compared to $32.9 million in 2020.  The increase is primarily due to a increase in net interest income of $19.6 million, an increase in non-interest income of $4.7 million, a $1.3 million decrease in non-interest expense and a $7.9 million decrease in the credit loss provision, partially offset by a $9.5 million increase in tax expense.

Results of Operations—Comparison of Results of Operations for the Years Ended December 31, 2020 to December 31, 2019

Net Interest Income/Average Balance Sheet

In 2020, we generated fully-taxable equivalent net interest income of $104.8 million, an increase of $7.9 million, or 8.1%, from the net interest income produced in 2019. This increase was largely due to a 11.7% increase in the average balance of interest-earning assets, in part due to the PGBH acquisition and organic loan growth, partially offset by an 11 basis point decrease in the net interest margin. For the years ended December 31, 2020 and 2019 our reported net interest margin was 3.52% and 3.63%, respectively. Our net interest margin benefits from discount accretion on our purchased loan portfolios.

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Interest Income. Total interest income was $139.1 million in 2020 compared to $141.7 million in 2019. The $2.6 million, or 1.8%, decrease in total interest income was mainly due to a decrease in the average loan yield of 37 basis points. This was partially offset by increases in the average balance of total loans of $147.5 million, average balance of securities of $88.2 million, and average balance of Federal funds sold, cash equivalents and other investments of $77.5 million.

Interest and fees on loans was $133.9 million in 2020 compared to $135.2 million in 2019. The $1.3 million, or 0.94%, decrease in interest income on loans was primarily due to a 46 basis point decrease in the average yield on loans held for investment and 51 basis point decrease in the average yield on loans held for sale, partially offset by a $147.5 million increase in the average balance of held for investment and held for sale loans outstanding. The increase in the average balance of loans outstanding was primarily due to the PGBH acquisition in January 2020 plus organic growth in commercial real estate and single-family residential mortgage loans during 2020. The yield on the loan portfolio benefited from accretion income associated with purchase accounting discounts established on loans acquired in prior acquisitions. For the years 2020 and 2019, the reported yield on total loans was 5.19% and 5.65%, respectively. The impact of accretion income on our yield on total loans for the years 2020 and 2019 was to increase our reported yield on total loans by 0.08% and 0.11%, respectively. A substantial portion of our acquired loan portfolio that is subject to discount accretion consists of commercial real estate loans and single family residential mortgages.

Interest income from our securities portfolio increased $315,000, or 11.7%, to $3.0 million in 2020. The increase in interest income on securities was primarily due to an increased average balance of $88.2 million, or 93.1%, partially offset by a 120 basis point decrease in the average yield of securities.

Interest income on our federal funds sold, cash equivalents and other investments decreased $1.7 million, or 42.3%, to $2.3 million in 2020. The decrease in interest income on these earning assets was primarily due to by a 184 basis point decrease in average yield of cash equivalents, partially offset by a $77.5 million increase in the average balance. The increase in the average balance resulted from pending utilization of these funds to higher yielding loans and securities.

Interest Expense. Interest expense on interest-bearing liabilities decreased $10.5 million, or 23.4%, to $34.4 million in 2020 primarily due to a 67 basis point decrease in the average rate on these liabilities plus an increase in non-interest bearing deposits of $142.9 million, partially offset by a $188.2 million increase in the average balance of interest bearing liabilities.

Interest expense on total deposits decreased to $25.2 million in 2020. The $9.0 million, or 26.4%, decrease in interest expense on total deposits was primarily due to a 63 basis point decrease in the average rate paid on total interest bearing deposits, partially offset by a $168.5 million increase in the average balance of interest-bearing deposits. The increase in the average balance of deposits resulted primarily from the PGBH acquisition in early 2020 and organic growth in 2020.

Interest expense on borrowings decreased from $10.6 million in 2019 to $9.2 million or 13.8% in 2020. This decrease reflected decreased interest expense on subordinated notes, subordinated debentures, and other borrowed funds consisting of FHLB short-term and long-term advances. In 2020, the average rate on these liabilities was 3.70% compared to 4.66% in 2019. A five year FHLB advance was obtained in March 2020 to provide for additional liquidity.

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Provision for Loan Losses

The provision for loan losses in 2020 was $11.8 million compared to $2.4 million in 2019. The increase in the 2020 provision expense was primarily attributable to COVID-19 pandemic related market effects of $2.3 million, increases in the size of our overall loan portfolio, and increases in past due loans, substandard loans and impaired loans. Non-performing loans that increased during the year were individually analyzed, with $525,000 in 2020 and none in 2019, net addition to the allowance for loan losses.

Noninterest Income

Noninterest income decreased $4.3 million, or 23.4%, to $14.0 million in 2020 from $18.3 million in 2019.

Service charges, fees and others. The increase in noninterest income from service charges, fees and other income was primarily from service charges on the additional transactional deposit accounts originated organically and acquired in the PGBH acquisition in 2020.  In 2020, the income from interest rate lock commitments ("IRLCs") was $182,000 and was recorded as service charges, fees and other.  The income from forward mortgage loan sales commitments ("FMLSCs") was $78,000 and is reported in the income statement as a gain on derivatives.  There was no IRLC and FMLSC income in 2019.

Gain on sale of loans. The gain on sales of loans decreased $3.9 million due primarily to the decrease of $2.9 million in SFR mortgage loans sold and a $788,000 decrease in premiums received on SBA loans sold. Decreases in gain on sales of loans were due to decreases of $15.1 million on SBA loans sold and $288.3 million on mortgage loans held for sale.  The decrease in the mortgage loan sales is attributable to the change in market conditions in the secondary market primarily caused by COVID-19.

Loan servicing income, net of amortization. Servicing income decreased due to increased loan pre-payments in the SFR loans serviced causing a decrease in the volume of mortgage loans we are servicing. SBA loan servicing income increased due to a decline in SBA pre-payments.

Recoveries on loans acquired in business combinations. Recoveries on loans acquired in business combinations decreased by $59,000 to $84,000 in 2020 compared to $143,000 in 2019.

Gain on derivatives.  Due to the amount of loans that were committed to be delivered to FNMA at year-end, we recorded a derivative which resulted in a gain of $78,000 in 2020.

Cash surrender value income of bank owned life insurance. Cash surrender value income of BOLI decreased $8,000 due to slightly lower rates.

Gain on sales of securities, net. Gain on sales of securities, net was $210,000 in 2020 from the sale of $11.7 million securities.

Loss on Sale of OREO. In 2020, there were no sales of OREO. A $106,000 loss on sale of OREO was recognized in 2019 from the sale of two OREO properties.

Noninterest Expense

Noninterest expense increased $2.0 million, or 3.5%, to $59.5 million in 2020 from $57.5 million in 2019.

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Salaries and employee benefits. Salaries and employee benefits expense increased $403,000 due to severance pay to terminated employees in connection with the PGBH merger. The number of full-time equivalent employees were 366 in 2020, 355 in 2019 and 365 in 2018. None of our employees are represented by a labor union, or governed by any collective bargaining agreements. We consider relations with our employees to be satisfactory. On a periodic basis, the human resources department will advise senior management of the following human capital management metrics: (1) open positions, (2) overtime expense, (3) staff turnover, and (4) employee headcount.

Occupancy and equipment. Occupancy and equipment expense decreased $59,000 from 2019 to 2020 mainly due to closing three branches in 2020, partially offset by the addition of three branches in Chicago (one leased and two owned)  and opening one branch in Edison, New Jersey.

Data processing. Data processing expense increased $537,000 in 2020. This increase was primarily due to upgrading our infrastructure and also reflected the impact of increased processing costs incurred subsequent to the PGBH acquisition. Effective June 2019, the Company renegotiated its data processing master agreement with its vendor, under which the Company is allowed to offset future monthly data processing expenses up to approximately $2.2 million through January 2026. As of December 31, 2020, this offset benefit amounted to $1.6 million to be recognized through January 2026. Conversion expense associated with the PGBH and FAIC acquisitions is in the “other expenses” line item.

Legal and professional. Legal and professional expense increased $911,000 in 2020 due to increases in problem loan collection expenses, and commission expense recognized in connection with the purchase of a new branch location.

Office expenses. Office expenses comprised of communications, postage, armored car, and office supplies, decreased by $31,000 in 2020. The decrease was primarily due to cost saving implemented in 2020 (following the acquisition of PGBH in January).

Marketing and business promotion. Marketing and business promotion expense decreased $557,000. In 2020, marketing and promotion activity decreased due to COVID-19 pandemic.

Insurance and regulatory assessments. Insurance and regulatory assessments expense increased by $84,000 to $984,000 in 2020 compared to $900,000 in 2019, following the PGBH acquisition in 2020. The FDIC insurance assessment was $455,000 in 2020 and $386,000 in 2019, an increase of $69,000. The DFPI regulatory assessment increased by $14,000 from $149,000 for the year 2019 to $163,000 for year 2020.  The corporate insurance expenses (including directors and officers insurance and fidelity bond), were $363,000 for 2020 compared to $360,000 for 2019.

Amortization of intangibles. Amortization of intangibles totaled $1.4 million in 2020 as compared to $1.5 million for 2019. The decrease was due to continued amortization of the core deposit intangible asset, following the additional core deposit intangible asset of $491,000 recognized in connection with the PGBH acquisition.

OREO expenses. OREO expenses were $35,000 in 2020 and $337,000 in 2019. The $302,000 decrease was due to payments made for delinquent property taxes and construction costs during the year ended 2019.

Merger expenses. Merger expenses were $746,000 in 2020 compared to $471,000 in 2019. The 2020 and 2019 expenses are for the PGBH acquisition which closed in January 2020.

Other noninterest expenses. Other expenses increased by $885,000 from 2019, primarily due to the provision for credit losses associated with unfunded commitments as of the balance sheet date of $558,000 in 2020 compared to $137,000 in 2019. The off-balance sheet liabilities are letters of credit and other commitments to lend. The provision for off-balance sheet liabilities is a function of the volume of undisbursed loans and other loan commitments multiplied by a risk factor. Other expense increases included a $416,000 increase in mortgage servicing rights impairment due to write-downs reflecting the decline in market rates of interest.

Income Tax Expense

Income tax expense was $14.5 million in 2020 compared to $16.1 million in 2019, a decrease of $1.6 million or 9.8%. The effective tax rate for 2020 was 30.6% and 29.2% for 2019. Income tax expense for 2020 included a $26,000 benefit for stock options exercised and a $78,000 benefit for 2019.

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Net Income

Net income decreased $6.3 million to $32.9 million in 2020, compared to $39.2 million in 2019.  The decrease was primarily due to a decrease in net interest income of $1.5 million, a decrease in non-interest income of $4.3 million, a $2.0 million increase in non-interest expense and a $9.4 million increase in the loan loss provision, partially offset by a $10.5 million decrease in interest expense.

ANALYSIS OF FINANCIAL CONDITION

Assets

Total assets were $4.2 billion as of December 31, 2021 and $3.4 billion as of December 31, 2020. We increased our net loans held for investment by $221.0 million.  This increase was from organic loan growth. Organic loan growth increased mainly in commercial real estate loans and construction loans. Our mortgage loans held for sale decreased by $44.0 million in 2021. The increase in assets was funded by an increase in deposits of $750.4 million, and a $38.2 million increase in equity (primarily resulting from $56.9 million in net income, less $10.5 million in repurchase of common stock and $9.9 million in dividends paid).

Investment Securities. We manage our securities portfolio and cash to maintain adequate liquidity and to ensure the safety and preservation of invested principal, with a secondary focus on yield and returns. Specific goals of our investment portfolio are as follows:

Our investment portfolio is comprised primarily of U.S. government agency securities, corporate note securities, mortgage-backed securities backed by government-sponsored entities and taxable and tax exempt municipal securities.

Our investment policy is reviewed annually by our board of directors. Overall investment goals are established by our board, CEO, CFO and members of our Asset Liability Committee (“ALCO”) of our board of directors. Our board of directors has delegated the responsibility of monitoring our investment activities to our ALCO. Day-to-day activities pertaining to the securities portfolio are conducted under the supervision of our CEO and CFO. We actively monitor our investments on an ongoing basis to identify any material changes in the securities. We also review our securities for potential other-than-temporary impairment at least quarterly.

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The following table sets forth the book value and percentage of each category of securities at December 31, 2021, 2020 and 2019. The book value for securities classified as available for sale is equal to fair market value and the book value for securities classified as held to maturity is equal to amortized cost.

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The tables below set forth investment securities AFS and HTM for the periods presented.

The weighted-average yield on the total investment portfolio at December 31, 2021 was 1.03% with a weighted-average life of 3.8 years. This compares to a weighted-average yield of 1.14% at December 31, 2020 with a weighted-average life of 3.3 years. The weighted average life is the average number of years that each dollar of unpaid principal due remains outstanding. Average life is computed as the weighted-average time to the receipt of all future cash flows, using as the weights the dollar amounts of the principal pay-downs.

Approximately 17.1% of the securities in the total investment portfolio at December 31, 2021, are issued by the U.S. government or U.S. government-sponsored agencies and enterprises, which have the implied guarantee of payment of principal and interest. As of December 31, 2021, no U.S. government agency bonds are callable.

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The table below shows the Company’s investment securities’ amortized cost and fair value by maturity in the following maturity groupings as of December 31, 2021.  The amortized cost and fair value of the investment securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

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The tables below show the Company’s investment securities’ gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2021 and December 31, 2020. The unrealized losses on these securities were primarily attributed to changes in interest rates. The issuers of these securities have not, to our knowledge, evidenced any cause for default on these securities. These securities have fluctuated in value since their purchase dates as market interest rates have fluctuated. However, we have the ability and the intention to hold these securities until their fair values recover to cost or maturity. As such, management does not deem these securities to be other-than-temporarily-impaired A summary of our analysis of these securities and the unrealized losses is described more fully in Note 4 — Investment Securities in the notes to the 2021 consolidated financial statements included in the Form 10-K. Economic trends may adversely affect the value of the portfolio of investment securities that we hold.

The Company did not record any charges for other-than-temporary impairment losses for the twelve months ended December 31, 2021 and 2020.

Loans

The loan portfolio is the largest category of our earning assets. At December 31, 2021, total loans held for investment, net of ALLL, totaled $2.9 billion.

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The following table presents the balance and associated percentage of each major category in our loan portfolio at December 31 for the past five years:

Net loans held for investment increased $221.0 million, or 8.3%, to $2.9 billion at December 31, 2021 as compared to $2.7 billion at December 31, 2020. The increase in net loans resulted from organic growth.

Commercial and industrial loans. We provide a mix of variable and fixed rate C&I loans. The loans are typically made to small- and medium-sized manufacturing, wholesale, retail and service businesses for working capital needs, business expansions and for international trade financing. C&I loans include lines of credit with a maturity of one year or less, C&I term loans with maturities of five years or less, shared national credits with maturities of five years or less, mortgage warehouse lines with a maturity of one year or less, bank subordinated debentures with a maturity of 10 years, purchased receivables with a maturity of two months or less and international trade discounts with a maturity of three months or less. Substantially all of our C&I loans are collateralized by business assets or by real estate.

We originate commercial and industrial lines of credit, term loans, mortgage warehouse lines and international trade discounts which totaled $268.7 million as of December 31, 2021 and $290.1 million at December 31, 2020. The interest rate on these loans are generally Wall Street Journal Prime rate based.

The loan to value and the rate on the underlying loans are based on the policy guidance of the Company.

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Our trade finance unit supplies financial needs to many of our core customers including trade financing needs for many of our commercial and industrial loan customers. The unit provides international letters of credit, SWIFT, export advice, trade finance discounts and foreign exchange. Our trade finance area has a correspondent relationship with many of the largest banks in China, Taiwan, Vietnam, Hong Kong and Singapore. All of our international letters of credit, SWIFT, export advice and trade finance discounts are denominated in U.S. currency, and all foreign exchange is issued through a major bank that is also denominated in U.S. currency. As a result, we and our clients are not subject to foreign currency fluctuations, and, therefore, we do not have a need to engage in transactions designed to hedge against foreign currency fluctuations and risk.

Commercial and industrial loans decreased $21.4 million, or 7.4%, to $268.7 million as of December 31, 2021 compared to $290.1 million at December 31, 2020. This decrease resulted primarily from a $31.1 million decrease in mortgage warehouse lines, partially offset by a $15.4 million increase in commercial lines of credit.

Commercial real estate loans.  CRE loans include owner-occupied and non-occupied commercial real estate, multi-family residential and SFR loans originated for a business purpose. Except for the multi-family residential loan portfolio, the interest rate for the majority of these loans are Prime based and have a maturity of five years or less except for the SFR loans originated for a business purpose which may have a maturity of one year. The interest rate for multi-family residential loans are based on the 5-year treasury, are 10 year maturity with a five year fixed rate period followed by a five year floating rate period, and have a declining prepayment penalty for the first five years. At December 31, 2021, approximately 14.7% of the CRE portfolio consisted of fixed-rate loans. Our policy maximum loan-to-value ("LTV") is 75% for CRE loans. The total CRE portfolio totaled $1.2 billion at December 31, 2021 and $1.0 billion as of December 31, 2020, of which $222.8 million and $198.8 million, respectively, are secured by owner occupied properties. The multi-family residential loan portfolio totaled $545.9 million as of December 31, 2021 and $346.6 million as of December 31, 2020. The SFR loan portfolio originated for a business purpose totaled $65.6 million as of December 31, 2021 and $24.0 million as of December 31, 2020.

Construction & land development loans. Our construction and land development loans are comprised of residential construction, commercial construction and land acquisition and development construction. Interest reserves are generally established on real estate construction loans. These loans are typically Prime based and have maturities of less than 18 months. Our LTV policy limits are 75% for construction and land development loans. C&D loans increased $116.4 million or 62.3%, to $303.1 million at December 31, 2021 as compared to $186.7 million at December 31, 2020. This increase was primarily due to increases in residential construction loans. As of December 31, 2021 and 2020, our real estate construction loan portfolio was divided among the foregoing categories as shown in the table below.

SBA guaranteed loans. We are designated a Preferred Lender under the SBA Preferred Lender Program. We offer mostly SBA 7(a) variable-rate loans. We generally sell the 75% guaranteed portion of the SBA loans that we originate. Our SBA loans are typically made to small-sized manufacturing, wholesale, retail, hotel/motel and service businesses for working capital needs or business expansions. SBA loans can have any maturity up to 25 years. Typically, non-real estate secured loans mature in less than 10 years. Collateral may also include inventory, accounts receivable and equipment, and includes personal guarantees. Our unguaranteed SBA loans collateralized by real estate are monitored by collateral type and are included in our CRE Concentration Guidance.

We originate SBA loans through our branch staff, loan officers and through SBA brokers. In 2021, we originated $60.3 million in SBA loans, of which $22.5 million were PPP loans and $26.2 million were SBA 7A originations and $11.6 million were SBA 504 originations. Of SBA loan originations, $43.9 million or 72.8% were produced by branch staff and loan officers. The remaining $16.4 million or 27.2% was referred to us through SBA brokers.

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As of December 31, 2021 our SBA portfolio totaled $76.1 million of which $17.9 million is guaranteed by the SBA and $58.2 million is unguaranteed, of which $56.6 million is secured by real estate and $1.6 million is unsecured or secured by business assets. We monitor the unguaranteed portfolio by type of real estate collateral. As of December 31, 2021, $25.4 million or 43.6% is secured by hotel/motels; $5.0 million or 8.6% by gas stations; and $27.9 million or 47.9% in other real estate types. We further analyze the unguaranteed portfolio by location. As of December 31, 2021, $27.8 million or 47.8% is located in California; $6.0 million or 10.3% is located in Washington state; $5.1 million or 8.7% is located in Nevada; $5.0 million or 8.5% is located in Texas; $3.4 million or 5.8% is located in New York; and $11.0 million or 19.0% is located in other states.

SBA loans decreased $21.7 million, or 22.2%, to $76.1 million at December 31, 2021 compared to $97.8 million at December 31, 2020. This decrease was primarily due to SBA loan sales of $20.9 million, and $50.9 million in mainly PPP loan payments in 2021 less $22.5 million in PPP loan origination, and SBA 7A loans originations of $26.2 million.

SFR real estate loans. We originate qualified SFR mortgage loans and non-qualified, alternative documentation SFR mortgage loans through correspondent relationships or through our branch network or retail channel. The loan product is a five- or seven-year hybrid adjustable mortgage which re-prices between five or seven years to the one-year CMT plus 3.00%. The qualified SFR mortgage loans, 15-year and 30-year conforming mortgages, are originated by our branch network and are sold directly to FNMA within seven days of funding.

We originate these non-qualified SFR mortgage loans both to sell and hold for investment. The loans held for investment are generally originated through our retail branch network to our customers, many of whom establish a deposit relationships with us. During 2021, we originated $410.0 million of such loans through our retail channel, and $62.1 million through our wholesale and correspondent channel. We sell many of these non-qualified SFR mortgage loans to other Asian-American banks and private investors.

The loans sold to other banks are sold with no representation or warranties and with a replacement feature for the first 90-days if the loan pays off early.  For SFR loans sold to FNMA and to investment funds we provide limited representations and warranties and with a repurchase and premium refund for loans that become delinquent in the first 90-days or a premium refund if paid-off in the first 90-days with respect to all loans sold.  As a condition of the sale, the buyer must have the loans audited for underwriting and compliance standards.

During 2021, we originated $472.1 million of SFR mortgage loans and sold $276.7 million to FNMA, investment funds and other banks in our market. SFR real estate loans include home equity loans acquired in the LANB, FAIC and PGBH acquisitions. As of December 31, 2021, we had $3.9 million in home equity loans.

SFR real estate loans held for investment, which include $3.9 million of home equity loans, decreased $119.8 million, or 10.7%, to $1.0 billion as of December 31, 2021 as compared to $1.1 billion as of December 31, 2020. Loans held for sale decreased $44.0 million or 88.1% to $6.0 million as of December 31, 2021 compared to $50.0 million December 31, 2020. In addition, our SFR mortgage lending unit originates mortgage warehouse lines to our correspondents. These loans are included in our commercial and industrial lending unit and totaled $47.2 million as of December 31, 2021 and $78.3 million as of December 31, 2020.

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The loan maturities in the table below are based on contractual maturities as of December 31, 2021. As is customary in the banking industry, loans that meet underwriting criteria can be renewed by mutual agreement between us and the borrower. Because we are unable to estimate the extent to which our borrowers will renew their loans, the table is based on contractual maturities. As a result, the data shown below should not be viewed as an indication of future cash flows.