# FIVE STAR BANCORP (FSBC) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from FIVE STAR BANCORP's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1275168/000127516824000061/fsbc-20231231.htm
Accession: 0001275168-24-000061
Filing date: 2024-02-23
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/FSBC/
All MD&A years: /company/FSBC/mda/
Previous year: /company/FSBC/mda/fy2022/ (FY 2022)
Next year: /company/FSBC/mda/fy2024/ (FY 2024)

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

The following discussion and analysis presents management’s perspective on our financial condition and results of operations on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relate to activities primarily conducted by the Bank. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and the accompanying notes presented elsewhere in this

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Annual Report on Form 10-K. Average balances, including balances used in calculating certain financial ratios, are generally comprised of average daily balances.

To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of our future financial outcomes. In addition to containing historical information, this discussion contains forward-looking statements that involve risks, uncertainties, and assumptions that could cause results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the sections entitled “Cautionary Note Regarding Forward-Looking Statements” and “Part I, Item 1A. Risk Factors.” We assume no obligation to update any of these forward-looking statements, except to the extent required by law.

Company Overview

Headquartered in the greater Sacramento metropolitan area of California, Five Star Bancorp (“Bancorp” or the “Company”) is a bank holding company that operates through its wholly owned subsidiary, Five Star Bank, a California state-chartered non-member bank. We provide a broad range of banking products and services to small and medium-sized businesses, professionals, and individuals primarily in Northern California through seven branch offices. Our mission is to strive to become the top business bank in all markets we serve through exceptional service, deep connectivity, and customer empathy. We are dedicated to serving real estate, agricultural, faith-based, and small to medium-sized enterprises. We aim to consistently deliver value that meets or exceeds the expectations of our shareholders, customers, employees, business partners, and community. We refer to our mission as “purpose-driven and integrity-centered banking.” At December 31, 2023, we had total assets of $3.6 billion, total loans held for investment, net of allowance for credit losses, of $3.0 billion, and total deposits of $3.0 billion.

Key Factors Affecting our Business

Interest Rates

Net interest income is the most significant contributor to our net income and is the difference between the interest and fees earned on interest-earning assets and the interest expense incurred in connection with interest-bearing liabilities. Net interest income is primarily a function of the average balances and yields of these interest-earning assets and interest-bearing liabilities. These factors are influenced by internal considerations such as product mix and risk appetite as well as external influences such as economic conditions, competition for loans and deposits, and market interest rates.

The cost of our deposits and short-term borrowings is primarily based on short-term interest rates, which are largely driven by the Federal Reserve’s actions and market competition. The yields generated by our loans and securities are typically affected by short-term and long-term interest rates, which are driven by market competition and market rates often impacted by the Federal Reserve’s actions. The level of net interest income is influenced by movements in such interest rates and the pace at which such movements occur.

Interest rates have risen significantly following the historically low levels during the COVID-19 pandemic. Due to elevated levels of inflation and corresponding pressure to raise interest rates, the Federal Reserve announced in January 2022 that it would be slowing the pace of its bond purchasing and increasing the target range for the federal funds rate over time. The Federal Open Market Committee (“FOMC”) has since increased the target range eleven times throughout 2022 and 2023. As of December 31, 2023, the target range for the federal funds rate had been increased to 5.25% to 5.50%, and the FOMC signaled that it may be appropriate to lower interest rates in 2024 as part of a strategy to return inflation to normalized levels.

We anticipate that interest rates may be lowered over the next few years. Based on our liability sensitivity, a steepened yield curve could have a beneficial impact on our net interest income. Additionally, a continued flat yield curve would be expected to maintain our net interest income.

Factors Affecting Comparability of Financial Results

S Corporation Status

Beginning at our inception, we elected to be taxed for U.S. federal income tax purposes as an S Corporation. In conjunction with our IPO, we filed consents from the requisite amount of our shareholders to revoke our S Corporation election with the IRS, resulting in the commencement of our taxation as a C Corporation for U.S. federal and California state income tax purposes in the second quarter of fiscal year 2021. Prior to such revocation, our earnings were not subject to and we did not

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pay U.S. federal income tax, and we were not required to make any provision or recognize any liability for U.S. federal income tax in our consolidated financial statements. While we were not subject to and did not pay U.S. federal income tax, we were subject to and paid California S Corporation income tax at a current rate of 3.50%. Upon the termination of our status as an S Corporation, we commenced paying U.S. federal income tax and a higher California state income tax on our taxable earnings for each year (including the short year beginning on the date our status as an S Corporation terminated), and our consolidated financial statements reflect a provision for U.S. federal income tax and a higher California state income tax from that date forward. As a result of this change, the net income and EPS data presented in our historical financial statements for periods prior to the termination of our S Corporation status and the other related financial information set forth in this filing, which (unless otherwise specified) do not include any provision for U.S. federal income tax or the higher California state income tax rate, will not be comparable with our net income and EPS in periods after we commenced being taxed as a C Corporation. As a C Corporation, our net income is calculated by including a provision for U.S. federal income tax and a higher state income tax rate at a combined statutory rate of 29.22%.

The termination of our status as an S Corporation may also affect our financial condition and cash flows. Historically, we made quarterly cash distributions to our shareholders in amounts estimated by us to be sufficient for them to pay estimated individual U.S. federal and California state income tax liabilities resulting from our taxable income that was “passed through” to them. However, these distributions were not consistent, as sometimes the distributions were less than or in excess of the shareholders’ estimated U.S. federal and California state income tax liabilities resulting from their ownership of our stock. In addition, these estimates were based on individual income tax rates, which may differ from the rates imposed on the income of C Corporations. As a C Corporation, no income is “passed through” to any shareholders, but, as noted above, we commenced paying U.S. federal income tax and a higher California state income tax. However, in the event of an adjustment to our reported taxable income for periods prior to the termination of our S Corporation status, it is possible that our pre-IPO shareholders would be liable for additional income taxes for those prior periods. Pursuant to the Tax Sharing Agreement we entered into with such shareholders, upon our filing any tax return (amended or otherwise), in the event of any restatement of our taxable income or pursuant to a determination by, or a settlement with, a taxing authority, for any period during which we were an S Corporation, depending on the nature of the adjustment, we may be required to make a payment to such shareholders, who accepted distribution of the estimated balance of our federal AAA of $31.9 million under the Tax Sharing Agreement, in an amount equal to such shareholders’ incremental tax liability (including interest and penalties). In addition, the Tax Sharing Agreement provides that we will indemnify such shareholders with respect to unpaid income tax liabilities (including interest and penalties) to the extent that such unpaid income tax liabilities are attributable to an adjustment to our taxable income for any period after our S Corporation status terminated. The amounts that we have historically distributed to our shareholders may not be indicative of the amount of U.S. federal and California state income tax that we will be required to pay going forward. Depending on our effective tax rate and our future dividend rate, our future cash flows and financial condition could be positively or adversely affected compared to our historical cash flows and financial condition.

Furthermore, deferred tax assets and liabilities were recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of our existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of the change in tax rates resulting from becoming a C Corporation was recognized in net income in the year ended December 31, 2021.

Allowance for Credit Losses

On January 1, 2023, the Company adopted ASC 326, which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the CECL model. The CECL model applies to estimated credit losses on loans receivable, held-to-maturity debt securities, unfunded loan commitments, and certain other financial assets measured at amortized cost. Under ASC 326, available-for-sale debt securities are evaluated for impairment if fair value is less than amortized cost, with any estimated credit losses recorded through a credit loss expense and an allowance, rather than a write-down of the investment. Changes in fair value that are not credit-related will continue to be recorded in other comprehensive income. Under the CECL model, the calculated allowance for credit losses was $5.3 million higher on January 1, 2023 than the allowance under the incurred loss model. For further information, please see Note 2, Recently Issued Accounting Standards, in the notes to our audited consolidated financial statements included in this Annual Report on Form 10-K.

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Critical Accounting Estimates

Our consolidated financial statements are prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of our assets, liabilities, revenue, and expenses. We have identified certain policies and estimates as critical to our business operations and the understanding of our past or present consolidated financial condition and results of operations. These policies and estimates are considered critical because they have a material impact, or they have the potential to have a material impact, on our consolidated financial statements and because they require us to make significant judgments, assumptions, or estimates. We believe that the judgments, estimates, and assumptions used in the preparation of our financial statements are reasonable and appropriate, based on the information available at the time they were made. However, actual results may differ from those estimates, and these differences may be material.

Pursuant to the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), as an emerging growth company, we can elect to opt out of the extended transition period for adopting any new or revised accounting standards. We have elected not to opt out of the extended transition period, which means that when a standard is issued or revised and it has different application dates for public and private companies, we may adopt the standard on the application date for private companies.

We have elected to take advantage of the scaled disclosures and other relief under the JOBS Act, and we may take advantage of some or all of the reduced regulatory and reporting requirements that will be available to us under the JOBS Act, so long as we qualify as an emerging growth company.

Allowance for Credit Losses

The allowance for credit losses represents the estimated probable credit losses in our loan and investment portfolios and is estimated as of December 31, 2023 using CECL. The allowance for credit losses as of December 31, 2022 was estimated using the incurred loss model. The allowance for credit losses is established through a provision for credit losses charged to operations. Loans and investments are charged against the allowance for credit losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries of previously charged-off amounts, if any, are credited to the allowance for credit losses.

The allowance for credit losses is evaluated on a regular basis by management in consideration of optimistic, moderate, and pessimistic current conditions, and is based on management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions specifically impacting each loan type by purpose and by geography, and concentrations within the loan portfolio. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

A significant amount of the allowance for credit losses is measured on a collective (pool) basis by loan and investment security type when similar risk characteristics exist. Pools are determined based primarily on regulatory reporting codes as the loans and investment securities within each pool share similar risk characteristics and there is sufficient historical peer loss data from the FFIEC to provide statistically meaningful support in the models developed. Reserves for credit losses identified on a pooled basis are then adjusted for qualitative and other environmental factors to reflect current conditions. The most significant components of qualitative and environmental factors used to estimate the allowance for credit losses are adjustments relating to prevailing economic conditions, concentrations within the loan portfolio, and external factors. The prevailing economic conditions factor is estimated based on a range of potential economic conditions and is applied at both the portfolio and individual concentration level based on various factors. This estimate is subject to significant judgment and could potentially add $1.0 million based on existing loan balances, if not more, to the allowance for credit losses in pessimistic economic conditions. The concentrations within the loan portfolio factor is estimated based on significant concentrations within the loan portfolio. This estimate is subject to significant judgment and could potentially add $4.8 million based on existing loan balances, if not more, to the allowance for credit losses based on a pessimistic market outlook for the specifically identified concentrations. The external factor is estimated based on current external factors, including environmental factors, which could impact the loan portfolio. This estimate is subject to significant judgment and could potentially add $3.9 million based on existing loan balances, if not more, to the allowance for credit losses based on a pessimistic external factors.

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Executive Summary

Our strategic focus is to continue to grow organically by leveraging our existing core competencies and positioning our business for success in the evolving banking landscape. In leveraging our core competencies, we intend to:

•continue our organic lending growth in our market through our “purpose-driven and integrity-centered” approach to banking;

•continue to focus on and grow each of the diverse industry clusters throughout our market areas;

•build upon the strength of our brand to deepen and broaden client relationships and grow our deposit base;

•attract additional banking professionals with track records of driving revenue growth;

•maintain our disciplined credit underwriting and robust risk management;

•enhance our disciplined cost management culture;

•leverage our technology platforms to improve our efficiency; and

•further engage in the economic development of our communities and market areas.

Highlights of the financial results are presented in the following tables:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","December 31, 2023","","December 31, 2022"],["Selected financial condition data:"],["Total assets","","$","3,593,125","","","$","3,227,159"],["Total loans held for investment","","3,081,719","","","2,791,326"],["Total deposits","","3,026,896","","","2,782,004"],["Total subordinated notes, net","","73,749","","","73,606"],["Total shareholders\u2019 equity","","285,774","","","252,825"],["Asset quality ratios:"],["Allowance for credit losses to total loans held for investment","","1.12","%","","1.02","%"],["Allowance for credit losses to period end nonperforming loans","","17.53x","","70.27x"],["Non-accrual loans to period end loans","","0.06","%","","0.01","%"],["Capital ratios:"],["Total capital (to risk-weighted assets)","","12.30","%","","12.46","%"],["Tier 1 capital (to risk-weighted assets)","","9.07","%","","8.99","%"],["Common equity Tier 1 capital (to risk-weighted assets)","","9.07","%","","8.99","%"],["Tier 1 leverage","","8.73","%","","8.60","%"],["Total shareholders\u2019 equity to total assets","","7.95","%","","7.83","%"],["Tangible shareholders\u2019 equity to tangible assets1","","7.95","%","","7.83","%"]]
[[/GREPCENT_TABLE]]

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[[GREPCENT_TABLE]]
[["(dollars in thousands, except share and per share data)","","For the year ended"],["","December 31, 2023","","December 31, 2022"],["Selected operating data:"],["Net interest income","","$","110,880","","","$","103,070"],["Provision for credit losses","","4,000","","","6,700"],["Non-interest income","","7,511","","","7,157"],["Non-interest expense","","47,775","","","40,669"],["Net income","","47,734","","","44,801"],["Earnings per common share:"],["Basic","","$","2.78","","","$","2.61"],["Diluted","","$","2.78","","","$","2.61"],["Book value per share","","$","16.56","","","$","14.66"],["Tangible book value per share2","","$","16.56","","","$","14.66"],["Weighted average basic common shares outstanding","","17,166,592","","","17,128,282"],["Weighted average diluted common shares outstanding","","17,187,969","","","17,165,610"],["Shares outstanding at end of period","","17,256,989","","","17,241,926"],["Performance and other financial ratios:"],["ROAA","","1.44","%","","1.57","%"],["ROAE","","17.85","%","","18.80","%"],["Net interest margin","","3.42","%","","3.75","%"],["Cost of funds","","2.10","%","","0.57","%"],["Efficiency ratio","","40.35","%","","36.90","%"],["Average equity to average assets","","8.05","%","","8.38","%"],["Cash dividend payout ratio on common stock3","","26.98","%","","40.23","%"]]
[[/GREPCENT_TABLE]]

1Tangible shareholders’ equity to tangible assets is considered a non-GAAP financial measure. See the section entitled “Non-GAAP Financial Measures” for a reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measure. Tangible shareholders’ equity to tangible assets is defined as total equity less goodwill and other intangible assets, divided by total assets less goodwill and other intangible assets. The most directly comparable GAAP financial measure is total shareholders’ equity to total assets. We had no goodwill or other intangible assets at the end of any period indicated. As a result, tangible shareholders’ equity to tangible assets is the same as total shareholders’ equity to total assets at the end of each of the periods indicated.

2Tangible book value per share is considered a non-GAAP financial measure. See the section entitled “Non-GAAP Financial Measures” for a reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measure. Tangible book value per share is defined as total shareholders’ equity less goodwill and other intangible assets, divided by the outstanding number of common shares at the end of the period. The most directly comparable GAAP financial measure is book value per share. We had no goodwill or other intangible assets at the end of any period indicated. As a result, tangible book value per share is the same as book value per share at the end of each of the periods indicated.

3Cash dividend payout ratio on common stock is calculated as dividends on common shares divided by basic earnings per common share.

RESULTS OF OPERATIONS

The following discussion of our results of operations compares the year ended December 31, 2023 to the year ended December 31, 2022.

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Net Interest Income

Net interest income is the most significant contributor to our net income. Net interest income represents interest income from interest-earning assets, such as loans and investments, less interest expense on interest-bearing liabilities, such as deposits, FHLB advances, subordinated notes, and other borrowings, which are used to fund those assets. In evaluating our net interest income, we measure and monitor yields/rates on our interest-earning assets and interest-bearing liabilities as well as trends in our net interest margin. Net interest margin is a ratio calculated as net interest income divided by total interest-earning assets for the same period. We manage our earning assets and funding sources in order to maximize this margin while limiting credit risk and interest rate sensitivity to our established risk appetite levels. Changes in market interest rates and competition in our market typically have the largest impact on periodic changes in our net interest margin.

Net interest income increased by $7.8 million, or 7.58%, for the year ended December 31, 2023, compared to the year ended December 31, 2022, while our net interest margin decreased 33 basis points during the same period. The contraction of our net interest margin was primarily due to increased rates paid on interest-bearing liabilities in excess of increased yields earned on interest-earning assets. These changes relate to changes in the effective Federal Funds rate in each period. Additional detail relating to net interest margin in each period is provided below.

Average balance sheet, interest, and yield/rate analysis. The following table presents average balance sheet information, interest income, interest expense, and the corresponding average yield earned or rate paid for each period reported. The average balances are daily averages and include both performing and nonperforming loans.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","For the year ended December 31, 2023","","For the year endedDecember 31, 2022"],["","Average Balance","","Interest Income/Expense","","Average Yield/Rate","","Average Balance","","Interest Income/Expense","","Average Yield/Rate"],["Assets"],["Interest-earning deposits with banks1","","$","184,103","","","$","9,069","","","4.93","%","","$","260,679","","","$","3,696","","","1.42","%"],["Investment securities1,2","","113,515","","","2,600","","","2.29","%","","131,353","","","2,427","","","1.85","%"],["Loans held for investment and sale1, 3","","2,947,603","","","162,713","","","5.52","%","","2,353,148","","","111,795","","","4.75","%"],["Total interest-earning assets1","","3,245,221","","","174,382","","","5.37","%","","2,745,180","","","117,918","","","4.30","%"],["Interest receivable and other assets, net4","","75,741","","","","","","","99,946"],["Total assets","","$","3,320,962","","","","","","","$","2,845,126"],["Liabilities and shareholders\u2019 equity"],["Interest-bearing transaction accounts1","","$","312,944","","","$","3,321","","","1.06","%","","$","242,221","","","$","425","","","0.18","%"],["Savings accounts1","","140,060","","","3,073","","","2.19","%","","107,010","","","376","","","0.35","%"],["Money market accounts1","","1,263,539","","","33,932","","","2.69","%","","995,048","","","6,476","","","0.65","%"],["Time accounts1","","372,557","","","17,535","","","4.71","%","","203,392","","","3,646","","","1.79","%"],["Subordinated notes and other borrowings1","","93,279","","","5,641","","","6.05","%","","61,533","","","3,925","","","6.38","%"],["Total interest-bearing liabilities","","2,182,379","","","63,502","","","2.91","%","","1,609,204","","","14,848","","","0.92","%"],["Demand accounts","","844,057","","","","","","","982,915"],["Interest payable and other liabilities","","27,127","","","","","","","14,709"],["Shareholders\u2019 equity","","267,399","","","","","","","238,298"],["Total liabilities & shareholders\u2019 equity","","$","3,320,962","","","","","","","$","2,845,126"],["Net interest spread5","","","","","","2.46","%","","","","","","3.38","%"],["Net interest income/margin6","","","","$","110,880","","","3.42","%","","","","$","103,070","","","3.75","%"]]
[[/GREPCENT_TABLE]]

1Interest income/expense is divided by the actual number of days in the period multiplied by the actual number of days in the year to correspond to stated interest rate terms, where applicable.

2Yields on available-for-sale securities are calculated based on fair value. Investment security interest is earned on a 30/360 day basis monthly. Yields are not calculated on a tax-equivalent basis.

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3Non-accrual loans are included in total loan balances. No adjustment has been made for these loans in the yield calculations. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs. Allowance for credit losses is not included in total loan balances.

4Allowance for credit losses is included in interest receivable and other assets, net.

5Net interest spread represents the average yield earned on interest-earning assets minus the average rate paid on interest-bearing liabilities.

6Net interest margin is computed by calculating the difference between interest income and interest expense, divided by the average balance of interest-earning assets, then annualized based on the number of days in the given period.

Analysis of changes in interest income and expenses. 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 yields/rates. The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities. The effect of changes in volume is determined by multiplying the change in volume by the current period’s average yield/rate. The effect of rate changes is calculated by multiplying the change in average yield/rate by the previous period’s volume. Changes not solely attributable to volume or yields/rates have been allocated in proportion to the respective volume and yield/rate components.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","For the year ended December 31, 2023 compared to the year ended December 31, 2022"],["","Variance due to"],["","Volume","","Yield/Rate","","Total"],["Interest-earning deposits with banks","","$","(3,772)","","","$","9,145","","","$","5,373"],["Investment securities","","(409)","","","582","","","173"],["Loans held for investment and sale","","32,814","","","18,104","","","50,918"],["Total interest-earning assets","","28,633","","","27,831","","","56,464"],["Interest-bearing transaction accounts","","750","","","2,146","","","2,896"],["Savings accounts","","725","","","1,972","","","2,697"],["Money market accounts","","7,210","","","20,246","","","27,456"],["Time accounts","","7,962","","","5,927","","","13,889"],["Subordinated notes and other borrowings","","1,920","","","(204)","","","1,716"],["Total interest-bearing liabilities","","18,567","","","30,087","","","48,654"],["Changes in net interest income/margin","","$","10,066","","","$","(2,256)","","","$","7,810"]]
[[/GREPCENT_TABLE]]

Net interest income during the year ended December 31, 2023 increased $7.8 million compared to the year ended December 31, 2022. Net interest margin decreased 33 basis points compared to the prior year. The increase in net interest income is primarily attributable to an additional $50.9 million in interest income on loans due to increases in interest rates and average balances compared to the prior year. The average yield on loans increased 77 basis points compared to the prior year, while average balances increased 25.26%. The increase in interest income was partially offset by an increase in total interest expense of $48.7 million, which is primarily attributable to an additional $46.9 million in deposit interest expense due to increases in interest rates and average balances compared to the prior year. The cost of interest-bearing deposits increased 206 basis points compared to the prior year, while average balances increased 34.98%. In addition, the average balance of non-interest-bearing deposits decreased by $138.9 million year-over-year.

Provision for Credit Losses

The provision for credit losses is based on management’s assessment of the adequacy of our allowance for credit losses. Factors impacting the provision include inherent risk characteristics in our loan portfolio, the level of nonperforming loans and net charge-offs, both current and historic, local economic and credit conditions, the direction of the change in collateral values, and the funding probability on unfunded lending commitments. The provision for credit losses is charged against earnings in order to maintain our allowance for credit losses, which reflects management’s best estimate of forecasted life of credit losses inherent in our loan portfolio at the balance sheet date.

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Beginning January 1, 2023, we adopted ASC 326, which replaced the former “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the CECL model. The CECL model calculates reserves over the life of a financial instrument and is largely driven by portfolio characteristics, economic outlook, and other key methodology assumptions. Under the CECL model, the calculated allowance for credit losses was $5.3 million higher on January 1, 2023 than the allowance under the incurred loss model. Utilizing CECL may have an impact on our allowance for credit losses going forward and may result in a lack of comparability between the 2022 and 2023 periods.

We recorded a $4.0 million provision for credit losses in the year ended December 31, 2023, compared to a $6.7 million provision for credit losses for the year ended December 31, 2022. The provision expense declined year-over-year due to the $5.3 million adjustment to the allowance for credit losses recorded in connection with the adoption of CECL. As such, the provision expense required based on the CECL model was lower for the year ended December 31, 2023, as the adoption true-up entry was recorded on January 1, 2023. The provision recorded is primarily due to loan growth, loan type mix, and updates in the macroeconomic environment.

Non-interest Income

Non-interest income is a secondary contributor to our net income. Non-interest income consists of service charges on deposit accounts, net gain on sale of securities, gain on sale of loans, loan-related fees, FHLB stock dividends, earnings on BOLI, and other income.

The following table details the components of non-interest income for the periods indicated.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","For the year ended","","$ Change","","% Change"],["","December 31, 2023","","December 31, 2022"],["Service charges on deposit accounts","","$","575","","","$","467","","","$","108","","","23.13","%"],["Net gain (loss) on sale of securities","","(167)","","","5","","","(172)","","","(3,440.00)","%"],["Gain on sale of loans","","1,952","","","2,934","","","(982)","","","(33.47)","%"],["Loan-related fees","","1,719","","","2,207","","","(488)","","","(22.11)","%"],["FHLB stock dividends","","970","","","546","","","424","","","77.66","%"],["Earnings on BOLI","","510","","","412","","","98","","","23.79","%"],["Other income","","1,952","","","586","","","1,366","","","233.11","%"],["Total non-interest income","","$","7,511","","","$","7,157","","","$","354","","","4.95","%"]]
[[/GREPCENT_TABLE]]

Service charges on deposit accounts. The increase related to individually immaterial increases in fees earned for services and products to support deposit accounts including, but not limited to, service charges, wire transfer fees, check order fees, and debit card income.

Net gain (loss) on sale of securities. The increase in the net loss on sale of securities resulted from the sale of two municipal securities with a par value of approximately $0.8 million for a loss of approximately $0.2 million during the year ended December 31, 2023, compared to the sale of approximately $1.6 million of municipal securities, resulting in a gain of $5.0 thousand during the year ended December 31, 2022.

Gain on sale of loans. The decrease related primarily to an overall decline in the volume of loans sold during the year ended December 31, 2023, compared to the year ended December 31, 2022. During the year ended December 31, 2023, approximately $36.5 million of loans were sold with an effective yield of 5.35%, as compared to approximately $50.8 million of loans sold with an effective yield of 5.78% during the year ended December 31, 2022.

Loan-related fees. The decrease was primarily a result of: (i) a decrease of $0.6 million in swap referral fees and (ii) a decrease of $0.2 million in loan fee income earned on various loan types and services. These decreases were partially offset by: (i) a $0.2 million increase in rate lock fees earned and (ii) a $0.1 million increase in income earned from the credit card program recognized during the year ended December 31, 2023, compared to the year ended December 31, 2022.

FHLB stock dividends. The increase primarily relates to an increase in the number of FHLB Class B shares held for the year ended December 31, 2023, compared to the year ended December 31, 2022 combined with an overall increase in the annualized dividend rates earned year-over-year.

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Other income. The increase resulted primarily from a $1.7 million gain recorded on distributions received on investments in venture-backed funds during the year ended December 31, 2023, compared to a $0.4 million gain recognized during the year ended December 31, 2022.

Non-interest Expense

Non-interest expense includes salaries and employee benefits, occupancy and equipment, data processing and software, FDIC insurance, professional services, advertising and promotional, loan-related expenses, and other operating expenses. In evaluating our level of non-interest expense, we closely monitor the Company’s efficiency ratio, which is calculated as non-interest expense divided by the sum of net interest income and non-interest income. We constantly seek to identify ways to streamline our business and operate more efficiently in order to reduce our non-interest expense over time as a percentage of our revenue, while continuing to achieve growth in total loans and assets.

Over the past several years, we have invested significant resources in personnel, technology, and infrastructure. As we execute initiatives based on growth, we expect non-interest expense to grow. Non-interest expense has increased throughout the periods presented below; however, we expect our efficiency ratio will improve going forward due, in part, to our past investment in infrastructure.

The following table details the components of non-interest expense for the periods indicated.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","For the year ended","","$ Change","","% Change"],["","December 31, 2023","","December 31, 2022"],["Salaries and employee benefits","","$","27,097","","","$","22,571","","","$","4,526","","","20.05","%"],["Occupancy and equipment","","2,218","","","2,059","","","159","","","7.72","%"],["Data processing and software","","4,015","","","3,091","","","924","","","29.89","%"],["FDIC insurance","","1,557","","","850","","","707","","","83.18","%"],["Professional services","","2,575","","","2,467","","","108","","","4.38","%"],["Advertising and promotional","","2,403","","","1,908","","","495","","","25.94","%"],["Loan-related expenses","","1,192","","","1,287","","","(95)","","","(7.38)","%"],["Other operating expenses","","6,718","","","6,436","","","282","","","4.38","%"],["Total non-interest expense","","$","47,775","","","$","40,669","","","$","7,106","","","17.47","%"]]
[[/GREPCENT_TABLE]]

Salaries and employee benefits. The increase was the result of: (i) a $3.2 million increase in salaries, insurance, and benefits, of which approximately $1.2 million related to 10 new employees hired to support expansion into the San Francisco Bay Area and the remainder of the increase related to increased pay rates and promotions for existing employees; (ii) a $2.7 million decrease in loan origination costs due to lower production; and (iii) a $0.3 million increase in bonus expense due to an increase in the base salaries and number of employees eligible for bonuses in 2023. The increase was partially offset by a $1.8 million decline in commissions expense due to lower production during the year ended December 31, 2023, as compared to the year ended December 31, 2022.

Occupancy and equipment. The increase was the result of a $0.1 million increase in rent expense related to temporary office space to support our expansion into the San Francisco Bay Area during the second half of 2023 and a new office lease to support back office staff beginning during the fourth quarter of 2023.

Data processing and software. The increase related to: (i) increased usage of our digital banking platform; (ii) higher transaction volumes related to the increased number of loan and deposit accounts; and (iii) an increased number of licenses required for new users on our loan origination and documentation system.

FDIC insurance. The increase related primarily to a final rule adopted by the FDIC to increase initial base deposit insurance assessment rates for insured depository institutions by two basis points, beginning with the first quarterly assessment period of 2023. FDIC insurance also increased for the year ended December 31, 2023, compared to the year ended December 31, 2022 due to a $266.4 million increase in the assessment base period-over-period.

Professional services. The increase was due to a $0.5 million increase in audit, IT support, and other consulting fees for services provided for the year ended December 31, 2023, compared to the year ended December 31, 2022. This was partially offset by a decline of $0.3 million relating to: (i) $0.2 million of lower legal fees incurred relating to the

52

subordinated note offering and redemptions completed in 2022, which did not recur in 2023, and (ii) $0.1 million of lower recruiting fees incurred for the year ended December 31, 2023, compared to the year ended December 31, 2022.

Advertising and promotional. The increase was primarily due to an increased customer base and an increase in the number of Business Development Officers as of December 31, 2023, compared to December 31, 2022.

Other operating expenses. The increase is primarily related to: (i) a $0.3 million increase in IntraFi Network fees resulting from an overall increase in balances carried in the network; (ii) a $0.1 million increase in bank charges due to increased activity; (iii) a $0.1 million increase in insurance expenses; and (iv) a $0.1 million net increase in travel, conferences, memberships, and subscription expenses incurred. These increases were partially offset by $0.3 million of subordinated note issuance costs recognized as an other expense upon redemption of the subordinated notes in December 2022, which did not recur during the year ended December 31, 2023.

Provision for Income Taxes

Provision for income taxes increased by $0.8 million, or 4.57%, to $18.9 million for the year ended December 31, 2023, compared to $18.1 million for the year ended December 31, 2022. This increase is due to an increase in pre-tax income, partially offset by a decline in the effective tax rate for each period, from 28.73% to 28.34% for the years ended December 31, 2022 and December 31, 2023, respectively. The lower effective tax rate period-over-period related to multi-state tax return filings for the Company since its inception as a C Corporation.

FINANCIAL CONDITION SUMMARY

The following discussion compares our financial condition as of December 31, 2023 to our financial condition as of December 31, 2022. The following table summarizes selected components of our consolidated balance sheet as of December 31, 2023 and December 31, 2022.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","December 31, 2023","","December 31, 2022"],["Total assets","","$","3,593,125","","","$","3,227,159"],["Cash and cash equivalents","","321,576","","","259,991"],["Total investments","","111,160","","","119,744"],["Loans held for investment","","3,081,719","","","2,791,326"],["Total deposits","","3,026,896","","","2,782,004"],["Subordinated notes, net","","73,749","","","73,606"],["Total shareholders\u2019 equity","","285,774","","","252,825"]]
[[/GREPCENT_TABLE]]

Total Assets

At December 31, 2023, total assets were $3.6 billion, an increase of $366.0 million from $3.2 billion at December 31, 2022, primarily due to increases in total loans held for investment of $290.4 million and cash and cash equivalents of $61.6 million, partially offset by a $8.6 million decrease in investments.

Cash and Cash Equivalents

Total cash and cash equivalents were $321.6 million at December 31, 2023, an increase of $61.6 million from $260.0 million at December 31, 2022. The increase in cash and cash equivalents was primarily due to increases in deposits of $244.9 million and net income of $47.7 million, partially offset by loan originations, net of repayments, of $284.3 million.

Investment Portfolio

Our investment portfolio is primarily comprised of U.S. government agency securities, mortgage-backed securities, and obligations of states and political subdivisions, which are high-quality liquid investments. We manage our investment portfolio according to written investment policies approved by our board of directors. Our investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk and interest rate risk that is reflective

53

of the yields obtained on those securities. Most of our securities are classified as available-for-sale, although we have one long-term, fixed rate municipal security classified as held-to-maturity.

Our total securities available-for-sale and held-to-maturity amounted to $111.2 million at December 31, 2023 and $119.7 million at December 31, 2022, a decrease of $8.6 million year-over-year. The decrease was primarily due to principal paydowns of $10.3 million, partially offset by an improvement in the unrealized loss on securities of $2.3 million, primarily in our municipal securities portfolios. The improvement in the unrealized loss was recognized as a result of interest rate decreases that occurred during the period.

54

The following table presents the carrying value of our securities by their stated maturities, as well as the weighted average yields for each maturity range, as of December 31, 2023:

[[GREPCENT_TABLE]]
[["","","Due in one year or less","","Due after one year through five years","","Due after five years through ten years","","Due after ten years","","Total"],["(dollars in thousands)","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield"],["Available-for-sale:"],["U.S. government agency securities","","$","\u2014","","","\u2014","%","","$","800","","","3.44","%","","$","2,010","","","5.36","%","","$","7,731","","","5.77","%","","$","10,541","","","5.51","%"],["Mortgage-backed securities","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","609","","","2.74","%","","56,364","","","1.76","%","","56,973","","","1.77","%"],["Obligations of states and political subdivisions","","\u2014","","","\u2014","%","","367","","","0.84","%","","5,838","","","1.71","%","","32,254","","","1.76","%","","38,459","","","1.74","%"],["Collateralized mortgage obligations","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","332","","","1.76","%","","\u2014","","","\u2014","%","","332","","","1.76","%"],["Corporate bonds","","\u2014","","","\u2014","%","","1,778","","","1.25","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","1,778","","","1.25","%"],["Total available-for-sale","","\u2014","","","\u2014","%","","2,945","","","1.79","%","","8,789","","","2.62","%","","96,349","","","2.08","%","","108,083","","","2.12","%"],["Held-to-maturity:"],["Obligations of states and political subdivisions","","277","","","6.00","%","","935","","","6.00","%","","1,365","","","6.00","%","","500","","","6.00","%","","3,077","","","6.00","%"],["Total","","$","277","","","6.00","%","","$","3,880","","","2.81","%","","$","10,154","","","3.07","%","","$","96,849","","","2.10","%","","$","111,160","","","2.22","%"]]
[[/GREPCENT_TABLE]]

55

The following table presents the carrying value of our securities by their stated maturities, as well as the weighted average yields for each maturity range, as of December 31, 2022:

[[GREPCENT_TABLE]]
[["","","Due in one year or less","","Due after one year through five years","","Due after five years through ten years","","Due after ten years","","Total"],["(dollars in thousands)","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield","","Carrying Value","","Weighted Average Yield"],["Available-for-sale:"],["U.S. government agency securities","","$","\u2014","","","\u2014","%","","$","849","","","1.98","%","","$","2,625","","","3.61","%","","$","10,699","","","2.90","%","","$","14,173","","","2.98","%"],["Mortgage-backed securities","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","2","","","6.94","%","","61,269","","","1.67","%","","61,271","","","1.67","%"],["Obligations of states and political subdivisions","","501","","","2.80","%","","\u2014","","","\u2014","%","","4,761","","","1.63","%","","33,164","","","1.76","%","","38,426","","","1.76","%"],["Collateralized mortgage obligations","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","395","","","1.76","%","","395","","","1.76","%"],["Corporate bonds","","\u2014","","","\u2014","%","","1,723","","","1.25","%","","\u2014","","","\u2014","%","","\u2014","","","\u2014","%","","1,723","","","1.25","%"],["Total available-for-sale","","501","","","2.80","%","","2,572","","","1.49","%","","7,388","","","2.33","%","","105,527","","","1.82","%","","115,988","","","1.85","%"],["Held-to-maturity:"],["Obligations of states and political subdivisions","","417","","","6.00","%","","1,015","","","6.00","%","","1,470","","","6.00","%","","854","","","6.00","%","","3,756","","","6.00","%"],["Total","","$","918","","","4.25","%","","$","3,587","","","2.77","%","","$","8,858","","","2.94","%","","$","106,381","","","1.86","%","","$","119,744","","","1.98","%"]]
[[/GREPCENT_TABLE]]

Weighted average yield for securities available-for-sale is the projected yield to maturity given current cash flow projections for U.S. government agency securities, mortgage-backed securities, and collateralized mortgage obligations. For callable municipal securities and corporate bonds, weighted average yield is a yield to worst. Weighted average yield for securities held-to-maturity is the stated coupon of the bond.

56

Loan Portfolio

Our loan portfolio is our largest class of interest-earning assets and typically provides higher yields than other types of interest-earning assets. Associated with the higher yields is an inherent amount of credit risk, which we attempt to mitigate with strong underwriting. As of December 31, 2023 and 2022, our total loans amounted to $3.1 billion and $2.8 billion, respectively. The following table presents the balance and associated percentage of each major product type within our portfolio as of the dates indicated.

[[GREPCENT_TABLE]]
[["","","As of"],["(dollars in thousands)","","December 31, 2023","","December 31, 2022"],["","Amount","","% of Loans","","Amount","","% of Loans"],["Loans held for investment:"],["Real estate:"],["Commercial","","$","2,685,419","","","86.76","%","","$","2,394,674","","","85.44","%"],["Commercial land and development","","15,551","","","0.50","%","","7,477","","","0.27","%"],["Commercial construction","","62,863","","","2.03","%","","88,669","","","3.16","%"],["Residential construction","","15,456","","","0.50","%","","6,693","","","0.24","%"],["Residential","","25,893","","","0.84","%","","24,230","","","0.86","%"],["Farmland","","51,669","","","1.67","%","","52,478","","","1.87","%"],["Commercial:"],["Secured","","165,109","","","5.33","%","","165,186","","","5.89","%"],["Unsecured","","23,850","","","0.77","%","","25,431","","","0.91","%"],["Consumer and other","","38,166","","","1.23","%","","28,628","","","1.02","%"],["Loans held for investment, gross","","3,083,976","","","99.63","%","","2,793,466","","","99.66","%"],["Loans held for sale:"],["Commercial","","11,464","","","0.37","%","","9,416","","","0.34","%"],["Total loans, gross","","3,095,440","","","100.00","%","","2,802,882","","","100.00","%"],["Net deferred loan fees","","(2,257)","","","","","(2,140)"],["Total loans","","$","3,093,183","","","","","$","2,800,742"]]
[[/GREPCENT_TABLE]]

Commercial real estate loans consist of term loans secured by a mortgage lien on the real property, such as office and industrial buildings, manufactured home communities, self-storage facilities, hospitality properties, faith-based properties, retail shopping centers, and apartment buildings, as well as commercial real estate construction loans that are offered to builders and developers.

Commercial land and development and commercial construction loans consist of loans made to fund commercial land acquisition and development and commercial construction, respectively. The real estate purchased with these loans is generally located in or near our market.

Commercial loans consist of financing for commercial purposes in various lines of business, including manufacturing, service industry, and professional service areas. Commercial loans can be secured or unsecured but are generally secured with the assets of the company and/or the personal guaranty of the business owner(s).

Residential real estate and construction real estate loans consist of loans secured by single-family and multifamily residential properties, which are both owner-occupied and investor-owned.

57

The following tables present the commercial real estate loan balance, associated percentage of commercial real estate concentrations, estimated real estate collateral values, and related loan-to-value (“LTV”) ranges by collateral type as of the dates indicated. Revolving lines of credit with zero balance and 0.00% LTV are excluded from this table. Collateral values are determined at origination using third-party real estate appraisals or evaluations. Updated appraisals, which are included in the table below, are obtained for loans that are downgraded to watch or substandard. Loans over $2.0 million are reviewed annually, at which time an internal assessment of collateral values is completed.

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Loan Balance","","% of Commercial Real Estate","","Collateral Value","","Minimum LTV","","Maximum LTV"],["December 31, 2023"],["Manufactured home community","","$","813,687","","","30.30","%","","$","1,430,224","","","16.80","%","","74.52","%"],["RV Park","","343,817","","","12.80","%","","599,691","","","18.29","%","","75.00","%"],["Retail","","273,100","","","10.17","%","","540,660","","","6.89","%","","74.07","%"],["Multifamily","","211,598","","","7.88","%","","427,948","","","13.12","%","","75.00","%"],["Faith-based","","184,799","","","6.88","%","","488,160","","","8.33","%","","74.54","%"],["Mini storage","","176,380","","","6.57","%","","358,395","","","16.56","%","","70.00","%"],["Industrial","","173,192","","","6.45","%","","417,439","","","7.48","%","","83.26","%"],["Office","","135,928","","","5.06","%","","298,989","","","9.07","%","","73.52","%"],["All other types1","","372,918","","","13.89","%","","756,541","","","4.00","%","","152.33","%"],["Total2","","$","2,685,419","","","100.00","%","","$","5,318,047"],["December 31, 2022"],["Manufactured home community","","$","673,891","","","28.14","%","","$","1,174,642","","","17.10","%","","78.19","%"],["RV Park","","292,886","","","12.23","%","","506,041","","","18.64","%","","77.89","%"],["Retail","","264,599","","","11.05","%","","490,291","","","16.48","%","","73.93","%"],["Multifamily","","202,203","","","8.44","%","","459,695","","","14.19","%","","75.00","%"],["Industrial","","166,403","","","6.95","%","","366,291","","","10.77","%","","75.00","%"],["Mini storage","","158,650","","","6.63","%","","289,820","","","20.20","%","","70.04","%"],["Faith-based","","146,740","","","6.13","%","","383,321","","","3.19","%","","73.55","%"],["Office","","145,899","","","6.09","%","","310,248","","","6.66","%","","74.68","%"],["All other types1","","343,403","","","14.34","%","","704,984","","","\u2014","%","","152.96","%"],["Total2","","$","2,394,674","","","100.00","%","","$","4,685,333"]]
[[/GREPCENT_TABLE]]

1Types of collateral in the “all other types” category are those that individually make up less than 5.00% of the commercial real estate concentration.

2Minimum LTV and maximum LTV not shown for aggregated totals, as such values are meaningful only when presented by specific category.

Over the past several years, we have experienced significant growth in our loan portfolio, although the relative composition of the portfolio has not changed significantly. Our primary focus remains commercial real estate lending (including commercial, commercial land and development, and commercial construction), which constitutes 89.62% of loans held for investment at December 31, 2023. Commercial secured lending represents 5.35% of loans held for investment at December 31, 2023. We sell the guaranteed portion of all SBA 7(a) loans in the secondary market and will continue to do so as long as market conditions continue to be favorable.

We recognize that our commercial real estate loan concentration is significant within our balance sheet. Commercial real estate loan balances as a percentage of risk-based capital were 682.72% and 680.34% as of December 31, 2023 and December 31, 2022, respectively. We have established internal concentration limits in the loan portfolio for commercial real estate loans by sector (e.g., manufactured home communities, self-storage, hospitality, etc.). All loan sectors were within our established limits as of December 31, 2023. Additionally, our loans are geographically concentrated with borrowers and collateral properties primarily in California.

58

We believe that our past success is attributable to focusing on products and markets where we have significant expertise. Given our concentrations, we have established strong risk management practices, including risk-based lending standards, self-established product and geographical limits, annual evaluations of income property loans, and semi-annual top-down and bottom-up stress testing. We expect to continue growing our loan portfolio. We do not expect our product or geographic concentrations to materially change.

The following table sets forth the contractual maturities of our loan portfolio as of December 31, 2023:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Due in 1 year or less","","Due after 1 year through 5 years","","Due after 5 years through 15 years","","Due after 15 years","","Total"],["Real estate:"],["Commercial","","$","57,443","","","$","271,306","","","$","2,284,482","","","$","72,188","","","$","2,685,419"],["Commercial land and development","","11,406","","","3,353","","","792","","","\u2014","","","15,551"],["Commercial construction","","27,078","","","10,377","","","25,408","","","\u2014","","","62,863"],["Residential construction","","11,543","","","3,913","","","\u2014","","","\u2014","","","15,456"],["Residential","","286","","","5,916","","","18,735","","","956","","","25,893"],["Farmland","","2,835","","","3,932","","","44,902","","","\u2014","","","51,669"],["Commercial:"],["Secured","","36,844","","","48,491","","","90,826","","","412","","","176,573"],["Unsecured","","574","","","10,789","","","12,487","","","\u2014","","","23,850"],["Consumer and other","","857","","","5,638","","","31,671","","","\u2014","","","38,166"],["Total","","$","148,866","","","$","363,715","","","$","2,509,303","","","$","73,556","","","$","3,095,440"]]
[[/GREPCENT_TABLE]]

The following table sets forth the contractual maturities of our loan portfolio at December 31, 2022:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Due in 1 year or less","","Due after 1 year through 5 years","","Due after 5 years through 15 years","","Due after 15 years","","Total"],["Real estate:"],["Commercial","","$","19,406","","","$","227,519","","","$","2,083,818","","","$","63,931","","","$","2,394,674"],["Commercial land and development","","1,611","","","5,053","","","813","","","\u2014","","","7,477"],["Commercial construction","","1,957","","","37,510","","","49,202","","","\u2014","","","88,669"],["Residential construction","","594","","","4,783","","","1,316","","","\u2014","","","6,693"],["Residential","","348","","","6,635","","","16,248","","","999","","","24,230"],["Farmland","","992","","","5,685","","","45,801","","","\u2014","","","52,478"],["Commercial:"],["Secured","","36,154","","","46,814","","","88,418","","","3,216","","","174,602"],["Unsecured","","55","","","10,347","","","15,029","","","\u2014","","","25,431"],["Consumer and other","","1,321","","","8,234","","","19,067","","","6","","","28,628"],["Total","","$","62,438","","","$","352,580","","","$","2,319,712","","","$","68,152","","","$","2,802,882"]]
[[/GREPCENT_TABLE]]

59

The following table sets forth the sensitivity to interest rate changes of our loan portfolio at December 31, 2023:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Fixed Interest Rates","","Floating or Adjustable Rates","","Total"],["Real estate:"],["Commercial","","$","570,385","","","$","2,115,034","","","$","2,685,419"],["Commercial land and development","","10,081","","","5,470","","","15,551"],["Commercial construction","","\u2014","","","62,863","","","62,863"],["Residential construction","","3,913","","","11,543","","","15,456"],["Residential","","1,272","","","24,621","","","25,893"],["Farmland","","5,848","","","45,821","","","51,669"],["Commercial:"],["Secured","","38,029","","","138,544","","","176,573"],["Unsecured","","16,343","","","7,507","","","23,850"],["Consumer and other","","38,081","","","85","","","38,166"],["Total","","$","683,952","","","$","2,411,488","","","$","3,095,440"]]
[[/GREPCENT_TABLE]]

The following table sets forth the sensitivity to interest rate changes of our loan portfolio at December 31, 2022:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Fixed Interest Rates","","Floating or Adjustable Rates","","Total"],["Real estate:"],["Commercial","","$","552,206","","","$","1,842,468","","","$","2,394,674"],["Commercial land and development","","1,514","","","5,963","","","7,477"],["Commercial construction","","1,405","","","87,264","","","88,669"],["Residential construction","","3,366","","","3,327","","","6,693"],["Residential","","1,531","","","22,699","","","24,230"],["Farmland","","6,261","","","46,217","","","52,478"],["Commercial:"],["Secured","","37,517","","","137,085","","","174,602"],["Unsecured","","20,607","","","4,824","","","25,431"],["Consumer and other","","28,628","","","\u2014","","","28,628"],["Total","","$","653,035","","","$","2,149,847","","","$","2,802,882"]]
[[/GREPCENT_TABLE]]

Asset Quality

We manage the quality of our loans based upon trends at the overall loan portfolio level as well as within each product type. We measure and monitor key factors that include the level and trend of classified, delinquent, non-accrual, and nonperforming assets, collateral coverage, credit scores, and debt service coverage, where applicable. These metrics directly impact our evaluation of the adequacy of our allowance for credit losses.

Our primary objective is to maintain a high level of asset quality in our loan portfolio. We believe our underwriting practices and policies, established by experienced professionals, appropriately govern the risk profile for our loan portfolio. These policies are continually evaluated and updated as necessary. All loans are assessed and assigned a risk classification at origination based on underlying characteristics of the transaction, such as collateral cash flow, collateral coverage, and borrower strength. We believe that we have a comprehensive methodology to proactively monitor our credit quality after the origination process. Particular emphasis is placed on our commercial portfolio, where risk assessments are reevaluated as a result of reviewing commercial property operating statements and borrower financials. On an ongoing basis, we also monitor payment performance, delinquencies, and tax and property insurance compliance. We design our practices to facilitate the early detection and remediation of problems within our loan portfolio. Assigned risk classifications are an integral part of management’s assessment of the adequacy of our allowance for credit losses. We periodically employ the use of an independent consulting firm to evaluate our underwriting and risk assessment process. Like other financial

60

institutions, we are subject to the risk that our loan portfolio will be exposed to increasing pressures from deteriorating borrower credit due to general economic conditions and rising interest rates.

Nonperforming Assets

Our nonperforming assets consist of nonperforming loans and foreclosed real estate, if any. Nonperforming loans consist of non-accrual loans and loans contractually past due by 90 days or more and still accruing. Loans on which the accrual of interest has been discontinued are designated as non-accrual loans. Accrual of interest on loans is discontinued either when reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes contractually past due by 90 days or more with respect to interest or principal. When a loan is placed on non-accrual status, all interest previously accrued, but not collected, is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

SBA Loans

During 2023, the Company sold 143 SBA 7(a) loans with government-guaranteed portions totaling $36.5 million. The Company received gross proceeds of $38.4 million on the loans sold in 2023, resulting in a net gain on sale of $2.0 million.

During 2022, the Company sold 172 SBA 7(a) loans with government-guaranteed portions totaling $50.8 million. The Company received gross proceeds of $53.7 million on the loans sold in 2022, resulting in a net gain on sale of $2.9 million.

Non-accrual Loans

The following table provides details of our nonperforming and restructured assets and certain other related information as of the dates presented:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","December 31, 2023","","December 31, 2022"],["Non-accrual loans"],["Real estate:"],["Commercial","","$","1,893","","","$","106"],["Residential","","\u2014","","","175"],["Commercial:"],["Secured","","72","","","123"],["Total non-accrual loans","","1,965","","","404"],["Loans past due 90 days or more and still accruing"],["Total loans past due 90 days or more and still accruing","","\u2014","","","\u2014"],["Total nonperforming loans","","1,965","","","404"],["Real estate owned","","\u2014","","","\u2014"],["Total nonperforming assets","","$","1,965","","","$","404"],["Performing LMs (not included above)","","$","\u2014","","","$","\u2014"],["Allowance for credit losses to period end nonperforming loans","","1,752.70","%","","7,026.98","%"],["Nonperforming loans to loans held for investment","","0.06","%","","0.01","%"],["Nonperforming assets to total assets","","0.05","%","","0.01","%"],["Nonperforming loans plus performing LMs to loans held for investment","","0.06","%","","0.01","%"]]
[[/GREPCENT_TABLE]]

The ratio of nonperforming loans to loans held for investment was 0.06% at December 31, 2023, increasing from 0.01% as of December 31, 2022, as a result of financial challenges experienced by a small subset of our borrowers.

61

The ratio of the allowance for credit losses to period end non-accrual loans decreased from 7,026.98% as of December 31, 2022 to 1,752.70% as of December 31, 2023. This decrease was due to: (i) a 21.28% increase in the allowance for credit losses year-over-year and (ii) a 386.39% increase in non-accrual loans, due to an increase of $1.8 million in commercial real estate non-accrual loans year-over-year.

Potential Problem Loans

We utilize a risk grading system for our loans to aid us in evaluating the overall credit quality of our real estate loan portfolio and assessing the adequacy of our allowance for credit losses. All loans are grouped into a risk category at the time of origination. Commercial real estate loans over $2.0 million are reevaluated at least annually for proper classification in conjunction with our review of property and borrower financial information. All loans are reevaluated for proper risk grading as new information such as payment patterns, collateral condition, and other relevant information comes to our attention.

The banking industry defines loans graded substandard or doubtful as “classified” loans. Loans by credit quality risk rating were as follows as of the periods indicated:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Pass","","Watch","","Substandard","","Doubtful","","Total"],["December 31, 2023"],["Real estate:"],["Commercial","","$","2,658,504","","","$","25,023","","","$","1,892","","","$","\u2014","","","$","2,685,419"],["Commercial land and development","","15,551","","","\u2014","","","\u2014","","","\u2014","","","15,551"],["Commercial construction","","62,863","","","\u2014","","","\u2014","","","\u2014","","","62,863"],["Residential construction","","15,456","","","\u2014","","","\u2014","","","\u2014","","","15,456"],["Residential","","25,893","","","\u2014","","","\u2014","","","\u2014","","","25,893"],["Farmland","","51,669","","","\u2014","","","\u2014","","","\u2014","","","51,669"],["Commercial:"],["Secured","","150,451","","","14,586","","","72","","","\u2014","","","165,109"],["Unsecured","","23,850","","","\u2014","","","\u2014","","","\u2014","","","23,850"],["Consumer and other","","38,139","","","15","","","12","","","\u2014","","","38,166"],["Total","","$","3,042,376","","","$","39,624","","","$","1,976","","","$","\u2014","","","$","3,083,976"],["December 31, 2022"],["Real estate:"],["Commercial","","$","2,379,766","","","$","14,802","","","$","106","","","$","\u2014","","","$","2,394,674"],["Commercial land and development","","7,477","","","\u2014","","","\u2014","","","\u2014","","","7,477"],["Commercial construction","","82,769","","","5,900","","","\u2014","","","\u2014","","","88,669"],["Residential construction","","6,693","","","\u2014","","","\u2014","","","\u2014","","","6,693"],["Residential","","24,055","","","\u2014","","","175","","","\u2014","","","24,230"],["Farmland","","52,478","","","\u2014","","","\u2014","","","\u2014","","","52,478"],["Commercial:"],["Secured","","163,879","","","1,184","","","123","","","\u2014","","","165,186"],["Unsecured","","25,431","","","\u2014","","","\u2014","","","\u2014","","","25,431"],["Consumer and other","","28,602","","","\u2014","","","26","","","\u2014","","","28,628"],["Total","","$","2,771,150","","","$","21,886","","","$","430","","","$","\u2014","","","$","2,793,466"]]
[[/GREPCENT_TABLE]]

Loans designated as watch and substandard, which are not considered adversely classified, increased to $41.6 million at December 31, 2023 from $22.3 million at December 31, 2022. The increase related primarily to a $17.7 million increase in loans designated as watch for loans which have indicators of deficient loan quality and potential significant issues which are expected to be temporary in nature. There were no loans with doubtful risk grades at December 31, 2023 or December 31, 2022.

62

Allowance for Credit Losses - Loans

The allowance for credit losses - loans is established through a provision for credit losses charged to operations. Provisions are charged against the allowance for credit losses - loans when management believes that the collectability of the principal is unlikely. Subsequent recoveries of previously charged-off amounts, if any, are credited to the allowance for credit losses - loans.

The allowance for credit losses - loans is evaluated on a regular basis by management and is based on management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

At December 31, 2023, the Company’s allowance for credit losses - loans was $34.4 million, compared to $28.4 million at December 31, 2022. The $6.0 million increase in the allowance is due to a $5.3 million adjustment recorded in connection with the adoption of ASC 326 and a $4.0 million provision for credit losses recorded during the year ended December 31, 2023, partially offset by net charge-offs of $3.3 million during the year ended December 31, 2023.

While the entire allowance for credit losses - loans is available to absorb losses from any and all loans, the following table represents management’s allocation of our allowance for credit losses by loan category, and the balance of loans in each category as a percentage of total loans, for the periods indicated.

[[GREPCENT_TABLE]]
[["","","December 31, 2023","","December 31, 2022"],["(dollars in thousands)","","Allowance for Credit Losses","","% of Loans to Total Loans","","Allowance for Credit Losses","","% of Loans to Total Loans"],["Real estate:"],["Commercial","","$","29,015","","","86.76","%","","$","19,216","","","85.44","%"],["Commercial land and development","","178","","","0.50","%","","54","","","0.27","%"],["Commercial construction","","718","","","2.03","%","","645","","","3.16","%"],["Residential construction","","89","","","0.50","%","","49","","","0.24","%"],["Residential","","151","","","0.84","%","","175","","","0.86","%"],["Farmland","","399","","","1.67","%","","644","","","1.87","%"],["Commercial:"],["Secured","","3,314","","","5.70","%","","7,098","","","6.23","%"],["Unsecured","","189","","","0.77","%","","116","","","0.91","%"],["Consumer and other","","378","","","1.23","%","","347","","","1.02","%"],["Unallocated","","\u2014","","","\u2014","%","","45","","","\u2014","%"],["Total","","$","34,431","","","100.00","%","","$","28,389","","","100.00","%"]]
[[/GREPCENT_TABLE]]

The ratio of allowance for credit losses to total loans held for investment was 1.12% at December 31, 2023, as compared to 1.02% at December 31, 2022.

63

The following table provides information on the activity within the allowance for credit losses - loans as of and for the periods indicated:

[[GREPCENT_TABLE]]
[["","","As of and for the year ended"],["","","December 31, 2023","","December 31, 2022"],["(dollars in thousands)","","Activity","","% of Average Loans Held for Investment","","Activity","","% of Average Loans Held for Investment"],["Average loans held for investment","","$","2,937,899","","","","","$","2,343,401"],["Allowance for credit losses - loans","","$","28,389","","","","","$","23,243"],["Effect of adoption of ASC 326","","$","5,262","","","","","$","\u2014"],["Net (charge-offs) recoveries:"],["Commercial:"],["Secured","","$","(3,073)","","","(0.10)","%","","$","(1,486)","","","(0.06)","%"],["Unsecured","","(6)","","","\u2014","%","","(2)","","","\u2014","%"],["Consumer and other","","(111)","","","\u2014","%","","(66)","","","\u2014","%"],["Net charge-offs","","$","(3,190)","","","(0.11)","%","","$","(1,554)","","","(0.07)","%"],["Provision for credit losses","","$","3,970","","","","","$","6,700"],["Allowance for credit losses - loans","","$","34,431","","","","","$","28,389"],["Loans held for investment","","$","3,081,719","","","","","$","2,791,326"],["Allowance for credit losses - loans to loans held for investment","","1.12","%","","","","1.02","%"]]
[[/GREPCENT_TABLE]]

The allowance for credit losses - loans to loans held for investment increased from 1.02% as of December 31, 2022 to 1.12% as of December 31, 2023. Net charge-offs as a percent of average loans held for investment increased from 0.07% to 0.11% for the years ended December 31, 2022 and December 31, 2023, respectively.

Liabilities

During 2023, total liabilities increased by $333.0 million from $3.0 billion at December 31, 2022 to $3.3 billion at December 31, 2023. This increase was primarily due to an increase in total deposits of $244.9 million, comprised of increases of $385.0 million in interest-bearing deposits and $70.0 million in FHLB advances, partially offset by a decrease of $140.1 million in non-interest-bearing deposits.

Deposits

Representing 91.52% of our total liabilities as of December 31, 2023, deposits are our primary source of funding for our business operations.

Total deposits increased by $244.9 million, or 8.80%, to $3.0 billion at December 31, 2023 from $2.8 billion as of December 31, 2022. Deposit increases were primarily attributable to an increase in the number of new relationships, as well as normal fluctuations in our existing accounts. Non-interest-bearing deposits decreased by $140.1 million in 2023 to $0.8 billion, and represented 27.46% of total deposits at December 31, 2023, compared to 34.91% of total deposits at December 31, 2022. Our loan to deposit ratio was 102.19% at December 31, 2023, compared to 100.67% at December 31, 2022. The increase in the ratio coincided with growth in our business. We closely monitor the loan to deposit ratio for purposes of both operational objectives and regulatory capital compliance. We intend to continue to operate our business with close monitoring of the loan to deposit ratio.

64

The following tables summarize our deposit composition by average deposits and average rates paid for the periods indicated:

[[GREPCENT_TABLE]]
[["","","For the year ended"],["","","December 31, 2023","","December 31, 2022"],["(dollars in thousands)","","Average Amount","","Average Rate Paid","","% of Total Deposits","","Average Amount","","Average Rate Paid","","% of Total Deposits"],["Interest-bearing transaction accounts","","$","312,944","","","1.06","%","","10.67","%","","$","242,222","","","0.18","%","","9.57","%"],["Money market and savings accounts","","1,403,599","","","2.64","%","","47.85","%","","1,102,057","","","0.62","%","","43.55","%"],["Time accounts","","372,557","","","4.71","%","","12.70","%","","203,392","","","1.79","%","","8.04","%"],["Demand accounts","","844,057","","","\u2014","%","","28.78","%","","982,915","","","\u2014","%","","38.84","%"],["Total deposits","","$","2,933,157","","","1.97","%","","100.00","%","","$","2,530,586","","","0.43","%","","100.00","%"]]
[[/GREPCENT_TABLE]]

Uninsured and uncollateralized deposits totaled $1.0 billion and $1.2 billion at December 31, 2023 and 2022, respectively.

As of December 31, 2023, our 40 largest deposit relationships, each accounting for more than $10.0 million, totaled $1.5 billion, or 49.80% of our total deposits. The average age on deposit relationships of more than $5.0 million was approximately nine years. As of December 31, 2022, our 40 largest deposit relationships, each accounting for more than $10.0 million, totaled $1.5 billion, or 52.15% of our total deposits. Overall, our large deposit relationships have been relatively consistent over time and have helped to continue to grow our deposit base. Our large deposit relationships are comprised of the following entity types as of the periods indicated:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","December 31, 2023","","December 31, 2022"],["Municipalities","","$","693,685","","","$","601,968"],["Non-profits","","188,252","","195,996"],["Businesses","","525,193","","527,921"],["Brokered deposits","","100,128","","","124,993"],["Total","","$","1,507,258","","","$","1,450,878"]]
[[/GREPCENT_TABLE]]

Our largest single deposit relationship at December 31, 2023 and December 31, 2022 related to a government agency. The balances for this customer were $260.0 million, or approximately 8.59% of total deposits as of December 31, 2023, and $180.0 million, or 6.47% of total deposits as of December 31, 2022. As our demand deposits fluctuate during a rising rate environment, we have purchased brokered deposits as needed to supplement liquidity. We do not consider brokered deposits as core deposits, but as another deposit funding source for our loan growth.

The following table sets forth the maturity of time deposits as of December 31, 2023:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","$250,000 or Greater","","Less than $250,000","","Total","","Uninsured Portion"],["Remaining maturity:"],["Three months or less","","$","217,908","","","$","101,564","","","$","319,472","","","$","213,158"],["Over three through six months","","96,331","","","16,641","","","112,972","","","93,581"],["Over six through twelve months","","7,491","","","2,605","","","10,096","","","3,741"],["Over twelve months","","22,964","","","1,068","","","24,032","","","20,964"],["Total","","$","344,694","","","$","121,878","","","$","466,572","","","$","331,444"]]
[[/GREPCENT_TABLE]]

FHLB Advances and Other Borrowings

From time to time, we utilize short-term collateralized FHLB borrowings to maintain adequate liquidity. There were borrowings of $170.0 million and $100.0 million outstanding as of December 31, 2023 and 2022, respectively.

65

In 2022, we issued subordinated notes of $75.0 million. This debt was issued to investors in private placement transactions. See Note 9, Long Term Debt and Other Borrowings, in the notes to our audited consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding these subordinated notes. The proceeds of the notes qualify as Tier 2 capital for the Company under the regulatory capital rules of the federal banking agencies. The following table is a summary of our outstanding subordinated notes as of December 31, 2023:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","Issuance Date","","Amount of Notes","","Prepayment Right","","Maturity Date"],["Subordinated notes","","August 2022","","$","75,000","","","August 17, 2027","","September 1, 2032"],["Fixed at 6.00% through September 1, 2027, then three-month Term SOFR plus 329.0 basis points (8.62% as of December 31, 2023) through maturity"]]
[[/GREPCENT_TABLE]]

Shareholders’ Equity

Shareholders’ equity totaled $285.8 million at December 31, 2023 and $252.8 million at December 31, 2022. The increase in shareholders’ equity was primarily a result of net income recognized of $47.7 million and an increase of $1.7 million in accumulated other comprehensive income, partially offset by $12.9 million in cash distributions paid during the year ended December 31, 2023 and a reduction to retained earnings of $4.5 million, net of tax effect, due to the adoption of ASC 326.

Liquidity and Capital Resources

Liquidity Management

We manage liquidity based upon factors that include the level of diversification of our funding sources, the composition of our deposit types, the availability of unused funding sources, our off-balance sheet obligations, the amount of cash and liquid securities we hold, and the availability of assets to be readily converted into cash without undue loss. As the primary federal regulator of the Bank, the FDIC evaluates our liquidity on a stand-alone basis pursuant to applicable guidance and policies.

Liquidity refers to our capacity to meet our cash obligations at a reasonable cost. Our cash obligations require us to have cash flow that is adequate to fund loan growth and maintain on-balance sheet liquidity while meeting present and future obligations of deposit withdrawals, borrowing maturities, and other contractual cash obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints in accessing sources of funds, and the ability to convert assets into cash. Changes in economic conditions or exposure to borrower credit quality, capital markets, and operational, legal, or reputational risks could also affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity management.

The Company is a corporation separate and apart from the Bank and, therefore, must provide for its own liquidity, including liquidity required to meet its debt service requirements on its subordinated notes. The Company’s main source of cash flow is dividends declared and paid to it by the Bank. There are statutory and regulatory limitations that affect the ability of the Bank to pay dividends to the Company, including various legal and regulatory provisions that limit the amount of dividends the Bank can pay to the Company without regulatory approval. Under the California Financial Code, payment of a dividend from the Bank to the Company without advance regulatory approval is restricted to the lesser of the Bank’s retained earnings or the amount of the Bank’s net income from the previous three fiscal years less the amount of dividends paid during that period. We believe that these limitations will not impact our ability to meet our ongoing short-term cash obligations. For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs plus two years’ subordinated notes debt service. We continually monitor our liquidity position in order to meet all reasonably foreseeable short-term, long-term, and strategic liquidity demands. Management has established a comprehensive process for identifying, measuring, monitoring, and controlling liquidity risk. Because of its critical importance to the viability of the Bank, liquidity risk management is fully integrated into our risk management processes. Critical elements of our liquidity risk management include effective corporate governance, consisting of oversight by the board of directors and active involvement by management; appropriate strategies, policies, procedures, and limits used to manage and mitigate liquidity risk; comprehensive liquidity risk measurement and monitoring systems, including stress tests, that are commensurate with the complexity of our business activities; active management of intraday liquidity and collateral; an appropriately diverse mix of existing and potential future funding sources; adequate levels of highly liquid marketable securities free of legal, regulatory, or operational impediments that can be used to meet liquidity needs in stress situations; comprehensive contingency funding plans that sufficiently address potential adverse liquidity

66

events and emergency cash flow requirements; and internal controls and internal audit processes sufficient to determine the adequacy of the Bank’s liquidity risk management process.

Our liquidity position is supported by management of our liquid assets and liabilities and access to alternative sources of funds. Our liquidity requirements are met primarily through our deposits, FHLB advances, and the principal and interest payments we receive on loans and investment securities. Cash on hand, cash at third-party banks, investments available-for-sale, and maturing or prepaying balances in our investment and loan portfolios are our most liquid assets. Other sources of liquidity that are routinely available to us include funds from retail and wholesale deposits, advances from the FHLB, and proceeds from the sale of loans. Less commonly used sources of funding include borrowings from the Federal Reserve Bank of San Francisco discount window (“Federal Reserve Discount Window”), draws on established federal funds lines from unaffiliated commercial banks, and the issuance of debt or equity securities. In the first quarter of 2023, the Federal Reserve created the Bank Term Funding Program to provide depository institutions with additional funding, which allows any federally insured deposit institution to pledge its investment portfolio at par as collateral value. As of December 31, 2023, the Bank had neither used nor established borrowing capacity with the Bank Term Funding Program. We believe we have ample liquidity resources to fund future growth and meet other cash needs as necessary.

In addition, we have a shelf registration statement on file with the SEC registering $250.0 million for any combination of equity or debt securities, depository shares, warrants, purchase contracts, purchase units, subscription rights, and units in one or more offerings. Specific information on the terms of and the securities being offered will be provided at the time of any offering thereunder. Proceeds from any future offerings are expected to be used for corporate purposes or other purposes to be disclosed at the time of such offering.

Sources and Uses of Cash

Our executive officers and board of directors review our sources and potential uses of cash in connection with our annual budgeting process. Generally speaking, our principal funding source is cash from gathering of deposits, and our principal uses of cash include funding of loans, operating expenses, income taxes, and dividend payments, as described below. As of December 31, 2023, management believes the sources mentioned below will provide adequate liquidity during the next twelve months for the Bank to meet its operating needs.

Based on our current capital allocation objectives, during 2024, we project spending $0.4 million related to continued build-out of our IT systems and processes and allocating $13.8 million of cash for dividends on our common stock.

For the 12-month period ending December 31, 2024, we project that our fixed commitments could potentially include: (i) approximately $458.9 million to fund off-balance sheet commitments outstanding at December 31, 2023; (ii) $6.3 million for IT services, IT support, and compliance expenditures; and (iii) $1.3 million for operating leases. In future years, we expect that our main sources and uses of cash will relate primarily to regular operating activities.

Loans

Loans are a significant use of cash in daily operations, and a source of cash as customers make payments on their loans or as loans are sold to other financial institutions. Cash flows from loans are affected by the timing and amount of customer payments and prepayments, changes in interest rates, the general economic environment, competition, and the political environment.

During the year ended December 31, 2023, we had cash outflows of $284.3 million in loan originations and advances, net of principal collected, and $47.9 million in loans originated for sale.

Additionally, we enter into commitments to extend credit in the ordinary course of business, such as commitments to fund new loans and undisbursed construction funds. While these commitments represent contractual cash requirements, a portion of these commitments to extend credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. At December 31, 2023, total off-balance sheet commitments totaled $458.9 million. We expect to fund these commitments to the extent utilized primarily through the repayment of existing loans, deposit growth, and liquid assets.

Deposits

Deposits are our primary source of funding for our business operations, and the cost of deposits has a significant impact on our net interest income and net interest margin.

67

Our deposits are primarily made up of money market, interest checking, time, and non-interest-bearing demand deposits. Aside from commercial and business clients, a significant portion of our deposits are from municipalities and non-profit organizations. Cash flows from deposits are impacted by the timing and amount of customer deposits, changes in market rates, and collateral availability.

During the year ended December 31, 2023, we had cash inflows related to an increase in deposits of $244.9 million, primarily as a result of an increase in the number of new relationships, fluctuations in existing accounts, and new certificates of deposit.

Over the next twelve months, approximately $442.5 million of time deposits are expected to mature. In addition, we expect $24.0 million of time deposits to mature through 2028. As these time deposits mature, some of these deposits may not renew due to general competition. However, based on our historical runoff experience, we expect the outflow will not be significant and can be replenished through our organic growth in deposits. We believe our emphasis on local deposits, our recent San Francisco Bay Area expansion, and our liquid investment portfolio, combined with our third-party financing availability, as discussed below, provide a stable funding base. At December 31, 2023, cash and cash equivalents represented 10.62% of total deposits.

Investment Securities

Our investment securities totaled $111.2 million at December 31, 2023. Mortgage-backed securities and obligations of states and political subdivisions comprised 51.25% and 37.37% of our investment portfolio, respectively. Cash proceeds from mortgage-backed securities result from payments of principal and interest by borrowers. Cash proceeds from obligations of states and political subdivisions occur when these securities are called or mature. Assuming the current prepayment speed and interest rate environment, we expect to receive approximately $7.9 million from our securities over the next twelve months. In future periods, we expect to maintain approximately the same level of cash flows from our securities. Depending on market yield and our liquidity, we may purchase securities as a use of cash in our interest-earning asset portfolio.

During the year ended December 31, 2023, we had cash proceeds from sales, maturities, calls, and prepayments of securities of $10.8 million, partially offset by cash outflows of $1.2 million related to investment securities purchased. Additionally, at December 31, 2023, securities available-for-sale totaled $108.1 million, of which $104.4 million have been pledged as collateral for borrowings and other commitments.

Future Contractual Obligations

Our estimated future obligations as of December 31, 2023 include both current and long-term obligations. Under our operating leases as discussed in Note 15, Commitments and Contingencies, we have a current obligation of $1.3 million and a long-term obligation of $5.0 million. We also have a current obligation of $442.5 million and a long-term obligation of $24.0 million related to time deposits, as discussed in Note 8, Interest-Bearing Deposits. We have net subordinated notes of $73.7 million, all of which are long-term obligations. Finally, we have one significant contract for core processing services. While the actual obligation is unknown and dependent on certain factors, including volume and activity, when using our 2023 average monthly expense extrapolated over the remaining life of the contract, we estimate that our current obligation under this contract is $0.7 million. We do not have a long-term obligation under this contract until it is renewed.

Total Liquidity

Total liquidity (consisting of cash and cash equivalents and unused and immediately available borrowing capacity as set forth below) was approximately $1.4 billion as of December 31, 2023.

[[GREPCENT_TABLE]]
[["","","December 31, 2023","","Available"],["(dollars in thousands)","","Line of Credit","","Letters of Credit Issued","","Borrowings"],["FHLB advances","","$","996,712","","","$","681,500","","","$","170,000","","","$","145,212"],["Federal Reserve Discount Window","","770,572","","","\u2014","","","\u2014","","","770,572"],["Correspondent bank lines of credit","","175,000","","","\u2014","","","\u2014","","","175,000"],["Cash and cash equivalents","","\u2014","","","\u2014","","","\u2014","","","321,576"],["Total","","$","1,942,284","","","$","681,500","","","$","170,000","","","$","1,412,360"]]
[[/GREPCENT_TABLE]]

68

FHLB Financing

The Bank is a shareholder of the FHLB, which enables the Bank to have access to lower-cost FHLB financing when necessary. At December 31, 2023, the Bank had outstanding borrowings of $170.0 million and a total financing availability of $145.2 million, net of letters of credit issued of $681.5 million.

Federal Reserve Discount Window and Correspondent Bank Lines of Credit

At December 31, 2023, unused and available amounts for borrowing from the Federal Reserve Discount Window and correspondent bank lines of credit were $770.6 million and $175.0 million, respectively.

Dividends

A use of liquidity for the Company is shareholder dividends. Bancorp paid dividends to its shareholders totaling $12.9 million during the year ended December 31, 2023.

We expect to continue our current practice of paying quarterly cash dividends with respect to our common stock, subject to our board of directors’ discretion to modify or terminate this practice at any time and for any reason without prior notice. We believe our quarterly dividend rate per share, as approved by our board of directors, enables us to balance our multiple objectives of managing our business and returning a portion of our earnings to our shareholders. Assuming continued payment during 2024 at a rate of $0.20 per share, our average total dividend paid each quarter would be approximately $3.5 million based on the number of currently outstanding shares if there are no increases or decreases in the number of shares, and given that unvested RSAs share equally in dividends with outstanding common stock.

Impact of Inflation

Our consolidated financial statements and related notes have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations. Unlike most industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods or services.

Historical Information

The following table summarizes our consolidated cash flow activities:

[[GREPCENT_TABLE]]
[["(dollars in thousands)","","For the year ended December 31,","","$ Change"],["","2023","","2022"],["Net cash provided by operating activities","","$","38,914","","","$","45,975","","","$","(7,061)"],["Net cash used in investing activities","","(279,278)","","","(836,922)","","","557,644"],["Net cash provided by financing activities","","301,949","","","625,609","","","(323,660)"]]
[[/GREPCENT_TABLE]]

Operating Activities

Net cash provided by operating activities decreased by $7.1 million for the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to lower proceeds from sale of loans and a lower provision for credit losses. These declines were partially offset by higher net income and lower loans originated for sale. Cash provided by operating activities is subject to variability period-over-period as a result of timing differences, including with respect to the collection of receivables and payments of interest expense, accounts payable, and bonuses.

For additional information about our operating results, see “Results of Operations” above.

Investing Activities

Net cash used in investing activities decreased by $557.6 million for the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to lower originations of loans held for investment, net of repayments, and lower maturities, prepayments, and calls of securities available-for-sale.

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Financing Activities

Net cash provided by financing activities decreased by $323.7 million for the year ended December 31, 2023 compared to the year ended December 31, 2022, primarily due to lower year-over-year growth in total deposits, lower FHLB advances, and proceeds received from the subordinated note issuance during the year ended December 31, 2022, which did not recur in the year ended December 31, 2023.

Capital Adequacy

We manage our capital by tracking our level and quality of capital with consideration given to our overall financial condition, our asset quality, our level of allowance for credit losses, our geographic and industry concentrations, and other risk factors on our balance sheet, including interest rate sensitivity.

Bancorp and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements as set forth in the following tables can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our consolidated financial statements.

Historically, as a bank holding company with less than $3.0 billion in total consolidated assets and that met certain other criteria, we had been operating under the Small Bank Holding Company Policy Statement, which provides an exemption from the Federal Reserve’s generally applicable risk-based capital ratio and leverage ratio requirements. Having passed this threshold as of September 30, 2022, we are no longer subject to this policy statement and our capital adequacy is evaluated relative to the Federal Reserve’s generally applicable capital requirements. Additionally, as of June 30, 2023, the Company’s consolidated assets were in excess of $3.0 billion, and as a consequence, beginning in March 2024, the Company will no longer prepare and file financial reports with the Federal Reserve as a small bank holding company.

Under federal regulations implementing the Basel III framework, the Bank is subject to minimum risk-based and leverage capital requirements. The Bank is also subject to regulatory thresholds that must be met for an insured depository institution to be classified as “well-capitalized” under the prompt corrective action framework. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items, as calculated under regulatory accounting practices. Capital amounts for Bancorp and the Bank, as well as the Bank’s prompt corrective action classification, are also subject to qualitative judgments by the regulators about components of capital, risk weightings, and other factors. As of December 31, 2023, both Bancorp and the Bank were in compliance with all applicable regulatory capital requirements, and the Bank qualified as “well-capitalized” under the prompt corrective action framework.

Management reviews capital ratios on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. For all periods presented, the Bank’s ratios exceed the regulatory definition of “well-capitalized” under the regulatory framework for prompt corrective action, and Bancorp’s ratios exceed the minimum ratios that would be required for it to be considered a well-capitalized bank holding company.

The capital adequacy ratios as of December 31, 2023 and December 31, 2022 for Bancorp and the Bank are presented in the following tables. As of December 31, 2023 and December 31, 2022, Bancorp’s Tier 2 capital included subordinated

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notes, which were not included at the Bank level. Eligible amounts of subordinated notes included in Tier 2 capital will be phased out by 20% per year beginning five years before the maturity date of the notes.

[[GREPCENT_TABLE]]
[["Capital Ratios for Bancorp (dollars in thousands)","","Actual Ratio","","Required for Capital Adequacy Purposes1","","Ratio to be Well-Capitalized under Prompt Corrective Action Provisions"],["","Amount","","Ratio","","Amount","","Ratio","","Amount","","Ratio"],["December 31, 2023"],["Total capital (to risk-weighted assets)","","$","404,829","","","12.30","%","","$","259,090","","","8.00","%","","N/A","","N/A"],["Tier 1 capital (to risk-weighted assets)","","$","298,749","","","9.07","%","","$","197,534","","","6.00","%","","N/A","","N/A"],["Common equity tier 1 capital (to risk-weighted assets)","","$","298,749","","","9.07","%","","$","148,150","","","4.50","%","","N/A","","N/A"],["Tier 1 leverage","","$","298,749","","","8.73","%","","$","136,953","","","4.00","%","","N/A","","N/A"],["December 31, 2022"],["Total capital (to risk-weighted assets)","","$","366,113","","","12.46","%","","$","235,065","","","8.00","%","","N/A","","N/A"],["Tier 1 capital (to risk-weighted assets)","","$","263,993","","","8.99","%","","$","176,191","","","6.00","%","","N/A","","N/A"],["Common equity tier 1 capital (to risk-weighted assets)","","$","263,993","","","8.99","%","","$","132,144","","","4.50","%","","N/A","","N/A"],["Tier 1 leverage","","$","263,993","","","8.60","%","","$","122,788","","","4.00","%","","N/A","","N/A"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Capital Ratios for the Bank (dollars in thousands)","","Actual Ratio","","Required for Capital Adequacy Purposes","","Ratio to be Well-Capitalized under Prompt Corrective Action Provisions"],["","Amount","","Ratio","","Amount","","Ratio","","Amount","","Ratio"],["December 31, 2023"],["Total capital (to risk-weighted assets)","","$","392,114","","","11.93","%","","$","262,947","","","8.00","%","","$","328,684","","","10.00","%"],["Tier 1 capital (to risk-weighted assets)","","$","359,783","","","10.95","%","","$","197,211","","","6.00","%","","$","262,947","","","8.00","%"],["Common equity tier 1 capital (to risk-weighted assets)","","$","359,783","","","10.95","%","","$","147,908","","","4.50","%","","$","213,645","","","6.50","%"],["Tier 1 leverage","","$","359,783","","","10.52","%","","$","136,757","","","4.00","%","","$","170,946","","","5.00","%"],["December 31, 2022"],["Total capital (to risk-weighted assets)","","$","356,301","","","12.14","%","","$","234,795","","","8.00","%","","$","293,494","","","10.00","%"],["Tier 1 capital (to risk-weighted assets)","","$","327,788","","","11.17","%","","$","176,072","","","6.00","%","","$","234,763","","","8.00","%"],["Common equity tier 1 capital (to risk-weighted assets)","","$","327,788","","","11.17","%","","$","132,054","","","4.50","%","","$","190,745","","","6.50","%"],["Tier 1 leverage","","$","327,788","","","10.69","%","","$","122,652","","","4.00","%","","$","153,315","","","5.00","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["1","The listed capital adequacy ratios exclude capital conservation buffers."]]
[[/GREPCENT_TABLE]]

Recent Accounting Pronouncements

For a discussion of the expected impact of accounting pronouncements recently adopted and accounting pronouncements recently issued but not yet adopted by us as of December 31, 2023, see Note 2, Recently Issued Accounting Standards, in the notes to our audited consolidated financial statements included in this Annual Report on Form 10-K.

Non-GAAP Financial Measures

Some of the financial measures discussed herein are non-GAAP financial measures. In accordance with SEC rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded,

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as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP in our consolidated statements of income, balance sheets, statements of shareholders’ equity, or statements of cash flows.

Tangible shareholders’ equity to tangible assets is defined as total equity less goodwill and other intangible assets, divided by total assets less goodwill and other intangible assets. The most directly comparable GAAP financial measure is total shareholders’ equity to total assets. We had no goodwill or other intangible assets at the end of any period indicated. As a result, tangible shareholders’ equity to tangible assets is the same as total shareholders’ equity to total assets at the end of each of the periods indicated.

Tangible book value per share is defined as total shareholders’ equity less goodwill and other intangible assets, divided by the outstanding number of common shares at the end of the period. The most directly comparable GAAP financial measure is book value per share. We had no goodwill or other intangible assets at the end of any period indicated. As a result, tangible book value per share is the same as book value per share at the end of each of the periods indicated.

We believe that these non-GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, results of operations, and cash flows computed in accordance with GAAP. However, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other banking companies use. Other banking companies may use names similar to those we use for the non-GAAP financial measures we disclose, but may calculate them differently. You should understand how we and other companies each calculate non-GAAP financial measures when making comparisons.