Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as definedcompany. See definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act).Act.
Table of Contents
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
All references to ‘‘we,’’ ‘‘our,’’ ‘‘us,’’ ‘‘Luther Burbank Corporation’’ or ‘‘the Company’’ refers to Luther Burbank Corporation, a California corporation, and our consolidated subsidiaries, including Luther Burbank Savings, a California banking corporation, unless the context indicates that we refer only to the parent company, Luther Burbank Corporation. ‘‘Bank’’ or ‘‘LBS’’ refers to Luther Burbank Savings, our banking subsidiary.
This Annual Report on Form 10-Kdocument contains a number of forward-looking statements. These forward-looking statements reflectwithin the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including our current views with respect to, among other things, future events and our results of operations, financial condition, and financial performance.performance, plans and/or strategies. These forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and may be identified by use of words such as "anticipate," "believe," “continue,” "could," "estimate," "expect," “impact,” "intend," "seek," "may," "outlook," "plan," "potential," "predict," "project," "should," "will," "would" and similar terms and phrases, including references to assumptions. Forward-lookingThese forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control.control and involve a number of risks and uncertainties. Accordingly, we caution you that any such forward-looking statements arestatement is not guaranteesa guarantee of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.statements due to a number of factors, including without limitation:
There are numerous, important factors that could cause•interest rate, liquidity, economic, market, credit, operational and inflation risks associated with our actual resultsbusiness, including the speed and predictability of changes in these risks;
•our ability to differ materially from those indicated in forward-looking statements, including, but not limited to,retain deposits and attract new deposits and loans and the following:composition and terms of such deposits and loans;
•business and economic conditions generally and in the financial services industry, nationally and within our current and future geographic markets, including the tight labor market, ineffective management of the U.S. Federal budget or debt or turbulence or uncertainty in domestic or foreign financial markets;
economic, market operational, liquidity, credit•any failure to adequately manage the transition from LIBOR as a reference rate;
•changes in the level of our nonperforming assets and interest rate risks associated withcharge-offs;
•the adequacy of our business;allowance for loan losses;
the occurrence of significant natural or man-made disasters, including fires, earthquakes and terrorist acts;
•our management of risks inherent in our real estate loan portfolio, including the seasoning of the portfolio, the level of non-conforming loans, the number of large borrowers, and the risk of a prolonged downturn in the real estate market;
•significant market which could impairconcentrations in California and Washington;
•the occurrence of significant natural or man-made disasters (including fires, earthquakes and terrorist acts), severe weather events, health crises and other catastrophic events;
•climate change, including any enhanced regulatory, compliance, credit and reputational risks and costs;
•political instability or the effects of war or other conflicts, including, but not limited to, the current conflict between Russia and Ukraine;
•the announced merger with Washington Federal, Inc., including delays in the consummation of the merger or litigation or other conditions that may cause the parties to abandon the merger or make the merger more expensive or less beneficial;
•the impact that the announced merger may have on our ability to attract and retain customers and key personnel, the value of our collateral andshares, our expenses, and/or our ability to sell collateral upon any foreclosure;conduct our business in the ordinary course and execute on our strategies;
•the performance of our ability to achieve organic loanthird-party vendors;
•fraud, financial crimes and deposit growthfund transfer errors;
•failures, interruptions, cybersecurity incidents and the compositiondata breaches involving our data, technology and systems and those of such growth;our customers and third-party providers;
the fiscal position of the U.S. and the soundness of other financial institutions;
•rapid technological changes in consumer spending and savings habits;the financial services industry;
technological and social media changes;•any inadequacy in our risk management framework or use of data and/or models;
•the laws and regulations applicable to our business, and the impact of recent and future legislative and regulatory changes;
•changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or our subsidiary bank in particular, more restrictive regulatory capital requirements, increased costs, including deposit insurance premiums, regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products;
increased competition in the financial services industry;
changes in the level of our nonperforming assets and charge-offs;
•our involvement from time to time in legal proceedings and examinationexaminations and remedial actions by regulators;
•increased competition in the composition of our management teamfinancial services industry; and our ability to attract and retain key personnel;
material weaknesses•changes in our internal control over financial reporting;reputation.
systems failures or interruptions involving our information technology and telecommunications systems;
potential exposure to fraud, negligence, computer theft and cyber-crime; and
the obligation associated with being a public company.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Annual Report. If one or more events related to these orReport on Form 10-K ("Annual Report"), including under the caption “Risk Factors” in Item 1A of Part I and other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from whatreports we anticipate. Accordingly, youfile with the Securities and Exchange Commission ("SEC"). You should not place undue reliance on any suchof these forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition,otherwise, except as required by law.
we cannot assess the impact
PART I.
Item 1. Business
General
Luther Burbank Corporation is a bank holding company incorporated on May 14, 1991 under the laws of the state of California and is headquartered in Santa Rosa, California. The Company operates primarily through theirits wholly-owned subsidiary, Luther Burbank Savings, a California banking corporation originally chartered in 1983 in Santa Rosa, California as a California savingsCalifornia. The Bank conducts its business from its executive offices in Santa Rosa and loan association. Luther Burbank Savings converted to a federal savings association in 1998 and subsequently converted to a California commercial bank charter in 2016. In December 2017, in conjunction with our initial public offering, the Company terminated its status as an S Corporation and elected to be treated as a C Corporation. As of December 1, 2017, the Company's taxable earnings have been subject to U.S. federal income tax.Gardena, CA.
The Company also owns Burbank Financial Inc., a real estate investment company, and Luther Burbank Statutory Trusts I and II, entities created to issue trust preferred securities.
The Company's principal business is attracting deposits from the general public and investing those funds in a variety of real estate loans, including permanent mortgage loans and construction loans secured by residential, multifamily, and commercial real estate. The Company specializes in real estate secured lending in metropolitan areas alongin the West Coastwestern U.S. and has developed special expertise in multifamily residential, jumbo nonconforming single family residential and commercial real estate lending.
Our Initial Public OfferingRecent Developments
Our initial public offering, or IPO, closed on December 12, 2017On November 13, 2022, the Company entered into an Agreement and a totalPlan of 13,972,500Reorganization (the “Merger Agreement”) with Washington Federal, Inc. (“WAFD”), pursuant to which the Company will merge with and into WAFD (the “Corporate Merger”), with WAFD surviving the Corporate Merger. Promptly following the Corporate Merger, the Company’s wholly-owned bank subsidiary, Luther Burbank Savings, will be merged with and into Washington Federal Bank, dba WaFd Bank, the wholly-owned bank subsidiary of WAFD (“WAFD Bank”), with WAFD Bank as the surviving institution. In accordance with the terms of the Merger Agreement, the Company’s shareholders will receive 0.3353 shares of WAFD common stock were sold at $10.75 perfor each share including 1,822,500 shares of common stock subject to the underwriters’ over-allotment option, which was exercised in full. After deducting underwriting discounts and offering expenses, the Company received total net proceeds of $138.3 million from the initial public offering and the exercise of the underwriter option. Upon completionCompany's issued and outstanding common stock. Closing of the IPO,transaction, which is expected to occur in 2023, is contingent upon shareholder approval and receipt of all necessary regulatory approvals, along with the Company became a publicly traded company with our common stock listed on The NASDAQ Global Select Market under the symbol “LBC”.
Implications of being an emerging growth company
As a company with less than $1.07 billion in revenue during our last fiscal year, we qualify as an ‘‘emerging growth company’’ under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting requirements and is relievedsatisfaction of other significant requirements that are otherwise generally applicable to other public companies. Among other factors, as an emerging growth company:
we may present only two years of audited financial statements, discuss only our results of operations for two years in ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ and provide less than five years of selected financial data;
we are exempt from the requirement to provide an opinion from our auditors on the design and operating effectiveness of our internal control over financial reporting pursuant to the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act;
we may choose not to comply with any new requirements adopted by the Public Company Accounting Oversight Board, or PCAOB;
we are permitted to provide less extensive disclosure regarding our executive compensation arrangements pursuant to the rules applicable to smaller reporting companies, which means we do not have to include a compensation discussion and analysis and other disclosure regarding our executive compensation in this Annual Report; and
we are not required to hold nonbinding advisory votes on executive compensation or golden parachute arrangements.
We may take advantage of these provisions for up to five years unless we earlier cease to qualify as an emerging growth company. We will cease to qualify as an emerging growth company if we have more than $1.07 billion in annual gross revenues, as that amount may be periodically adjusted by the Securities and Exchange Commission, or SEC, we become a ‘‘large accelerated filer,’’ including having more than $700.0 million in market value of our common stock held by non-affiliates, or we issue more than $1.0 billion of non-convertible debt in a three-year period.
We expect to take advantage of the reduced reporting and other requirements of the JOBS Act with respect to the periodic reports we will file with the SEC and proxy statements that we use to solicit proxies from our shareholders.
customary closing conditions.
Business Strategies
We intend to continue executing our strategic plan by focusing on the following key objectives:
•Continued organic lending growth in our existing markets and in new strategically targetedstrategic markets. Our primary focus is to grow our clientcustomer base within our strategic markets and to expand the penetration of our existing multifamily, single family and commercial real estate lending activities into additional contiguouswithin these markets onin the West Coastwestern United States, which have historically had strong job growth, strong economic growth and limited affordable housing. As part of these efforts, we recently extended our multifamily and our single family residential lending operations to Portland, Oregon. We intend to incorporate allThese markets include major metropolitan markets betweenin the western U.S., including our existing markets, resulting in a contiguous footprint from Seattlerecent expansion to San Diego.Arizona, Colorado and Utah. The high cost of living and high barriers to entry make these markets attractive targets for investments in affordable rental housing for lowlow- and middle incomemiddle-income tenants. Robust job markets, strong single family residential demand, high average housing cost,costs, and concentrations of professional, highly skilled and high income workers, entrepreneurs and other high net worth individuals make our markets ideal for our portfolio single family residential lending activities.
We believe we have a competitive advantage over larger national financial institutions, which lack our level of personalized service, and over smaller community banks, which lack our product and market expertise. We intend to capture additional market share by deepening our relationships with current customers and supporting our bankers in their pursuit of new customers in our target markets. We believe that our stable, income producing property focus and our existing customer profile lends itself to expanded lending in our existing markets, as well as new markets.
•Deepen clientcustomer relationships and grow our deposit base. We provide a high level of customer service to our depositors. Our historical focus for our deposit production activities was exclusively on individual savings deposits from high net worth, primarily self-employed individuals, entrepreneurs and professionals, and we did not emphasize transactional accounts. This strategy has produced a stable customer base. We have recently expanded our focus in recent years, and invested in personnel, business and compliance processes and technology that enable us to acquire, and efficiently and effectively serve, a widewider array of consumer transactional accounts and business deposit accounts and increase outreach in high-density, small to medium sized business markets where the Bank already operates while continuing to
provide the level of customer service for which we are known to our consumer depositors. We also provide comprehensive online and mobile banking products to our business and consumer depositors to complement our branch network.
We believe that our current customer base contains significant,additional untapped cross-selling opportunities. We plan to continue to grow our non-brokered, consumer and business deposits by:
•cross-selling business deposit relationships to our existing consumer customers who are business owners;operators;
•cross-selling business and consumer accounts to our multifamily and single family loan borrowers;
•obtaining new individual and business customers, including specialty deposit customers, such as escrow and title company depositors andfiduciary service providers, 1031 exchange companies;companies, unions, homeowners associations and nonprofits; and
establishing new branches in key California and Washington markets
•increasing our digital market presence including the use of social media.
We will also seekcontinue to cross-sell existing customers, and solicit new ones, for additional lending opportunities in our markets, and to develop niche verticals, where our credit underwriting expertise and efficient operations can yield an attractive risk-adjusted return. Our cross-selling efforts to existing customers will be strategically targeted, based on our in depth analyses of our customers’ overall financial profile, cash flows, financial resources and banking requirements, to drive traffic to branches. Our cross-selling efforts are in their very early stages, and we believe there is a significant capacity to expand deposit and lending relationships on this basis.requirements.
•Disciplined credit quality and robust risk management. We are committed to being a high performing
organization, and as we continueintend to grow our loan portfolio, we will do sooperate in a disciplined manner. Risk management is a core competency of our business, demonstrated by the strong credit performance of our portfolio. We have implemented comprehensive policies and procedures for credit underwriting, and monitoring our loan portfolio and internal risk management, managing our interest rate risk, compliance, reputation, legal risk and other risks inherent in our operations.management. The sound credit practices followed by our bankers allow credit decisions to be made efficiently and consistently. We attribute our success to a strong credit culture, the continuous evaluation of risk and return and the strict separation between business development and credit decision making, coupled with a robust risk management framework. Our focus on credit and risk management has enabled us to grow our balance sheetoriginate large volumes of loans successfully while maintaining strong asset quality.
•Disciplined cost management. We intend to continue to foster a culture of efficiency through hands-on management, prudent expense management, and a strategically small number of large deposit balance branches. WeWith a continuing emphasis on process improvements, we believe that we can support continued growth in assets, customers and our geographic footprint without significant additional investment in our infrastructure and technology, or significant expansion of our personnel. We believe that our existing network of branches and loan production offices, as well as nonbranchnon-branch and online customer and deposit development activities, have significant potential to continue to grow loan and deposit balances. While we intend toWe will continue to be highly selective as we explore opportunities for establishing additional strategically located branches in markets whichthat present significant opportunity for multifamily and commercial real estate lending, single family residential lending, and high net worth consumer and business banking relationships, including potential branches in the counties of Orange and/or San Diego, California and Seattle, Washington, we will continue to be highly selective in our branching decisions.
relationships.
Market Area
Our operations are currentlyprimarily concentrated in demographically desirable and fast growing major metropolitan areas on the West Coast. We currently operateCoast located in the states of California, Washington and Oregon from our nine branch officesOregon. We have ten full service branches in California located in Beverly Hills, Burbank, Encino, Long BeachSonoma, Marin, Santa Clara, and Pasadena, each in Los Angeles County, California, San Rafael,Counties and one full service branch in Marin County, California, Los Altos and San Jose, eachWashington located in Santa Clara County, California, and Santa Rosa, in Sonoma County, California.King County. We also operate nine lendingseveral loan production offices in the cities of Roseville, Santa Rosa, Emeryville, Walnut Creek, Manhattan Beach, Irvine and Solana Beach in California, Seattle, Washington, and since November 1, 2017, Portland, Oregon. We closed our Walnut Creek office on February 28, 2018 given its close proximity to our Emeryville location.located throughout California. We are most active in the following metropolitan areas: Santa Rosa (Sonoma County), Los Angeles, San Francisco, San Jose, San Diego, and Seattle. We are seeking to more deeply penetrate these core markets, and to increase our presence in contiguousother major metropolitan markets that share key demographic characteristics with our existing markets, solidifyingincluding our Seattle to San Diego footprint.recent expansion into Arizona, Colorado and Utah.
Competition
We operate in a highly competitive industry and in highly competitive markets throughout the West Coast, primarily in the markets in and around Los Angeles, Irvine, San Diego, and San Francisco, California, Seattle, Washington and Portland, Oregon.western United States. While our commercial real estate and jumbo single family residential focuses require significant expertise to perform efficiently, competition in commercial real estate lending is keen from large banking institutions with national
operations and mid-sized regional banking institutions. Ininstitutions, while in the single family lending market, we face stiff competition from a wide array of institutions. WeFor both lending and deposit customers, we compete with other community banks, savings and loan associations, credit unions, mortgage companies, insurance companies, finance companies, as well as other kinds of financial institutions and others providing financial services.enterprises, such as securities firms, insurance companies, private lenders and nontraditional competitors such as the U.S. Department of Treasury, fintech companies and internet-based lenders, depositories and payment systems. The primary factors driving competition for deposits are customer service, interest rates, fees charged, branch locations and hours, online and mobile banking functionality, and the range of products offered.offered and the reputation/public perception of an institution. The primary factors driving competition for our lending products are customer service, range of products offered, price, reputation, and quality of execution. We believe the bankBank is a strong competitor in our markets; however, other competitors have advantages over us. Among the advantages that many of these large institutions have over the Bank are their abilities to finance extensive advertising campaigns, maintain extensive branch networks, generate fee and other noninterest income, make larger technology investments and to offer services whichthat we do not offer. The higher capitalization of the larger institutions permits them to provide higher lending limits than we can, although our current lending limit is able to accommodate the credit needs of most of our borrowers. Some of these competitors have other advantages, such as tax exemption in the case of the U.S. Department of Treasury and credit unions, and to some extent, lesser regulation in the case of mortgage companies and finance companies.
Our primary multifamily competitor is JPMorgan Chase & Co. Additional competitors include, Opus Bank,but are not limited to, Pacific Premier Bancorp, Inc., First Foundation, Inc., BofI Holding, Inc.Homestreet Bank and Umpqua Bank. Our primary single family lending competitors in our markets are MUFG UnionFremont Bank, N.A.,WaFd Bank, Florida Capital Bank, various non-bank mortgage lenders, and large national banks. Our primary deposit
competitors are First Republiclocal regional banks, community banks, numerous credit unions and large national banks.
Lending Activities
The primary components of our loan portfolio are multifamily and commercial real estate loans and single family residential loans, primarily jumbo loans which do not meet the requirements for conforming loans.
•Multifamily and Commercial Real Estate Lending.
Our commercial real estate loans consist primarily of first mortgage loans made for the purpose of purchase, refinance or build-out of tenant improvements on investor owned multifamily residential (five or more units) properties. We also provide loans for the purchase, refinance or improvement of office, retail and light industrial properties. We do not currently finance land acquisition or commercial construction loans.
Our underwriting guidelines for multifamily and other commercial real estate loans require a thorough analysis of the financial performance, cash flows, loan to value and debt service coverage ratios, as well as the physical characteristics of the property being financed and which will stand as collateral for the loan, as well as the financial condition and global cash flows of the borrower and any guarantor or other secondary source of repayment. We also closely review the experience of the borrower and its principals in the ownership, successful management and financing of multifamily residential rental properties or other rental commercial real estate, as well as their reputation for quality business practices and financial responsibility and ethical business practices.responsibility.
The location of the property is a primary factor in the Bank’s multifamily lending. We focus on markets with a high barrier to entry for new development, where there is a limited supply of new housing and where there is a high variance between the cost to rent and the cost to own. Our core lending areas are currently defined as:
•Alameda, Contra Costa, Los Angeles, Marin, Napa, Orange, San Diego, San Francisco, San Mateo, Santa Barbara, Santa Clara, Sonoma and Ventura counties in California,California;
•Clark, King, Kitsap, Pierce and Snohomish counties in Washington andWashington;
Clark (WA), •Clackamas, Multnomah and Washington counties in Oregon.Oregon:
•Maricopa county in Arizona;
•Adams, Arapahoe, Boulder, Broomfield, Denver, Douglas, El Paso and Jefferson counties in Colorado; and
•Davis, Provo, Salt Lake, Utah and Weber counties in Utah.
Our extended core lending areas are currently defined as:
•El Dorado, Monterey, Placer, Riverside, Sacramento, San Bernardino, San Luis Obispo, Santa Cruz, Solano and SolanoYolo counties in California,California;
Clark, •Spokane and Thurston counties in WashingtonWashington; and
•Lane and Marion counties in Oregon.
We recently began offering products and services in Portland, Oregon. We may re-evaluate and revise the definitions of our core and extended core areas from time to time. Non-CoreNon-core markets include all markets in California, Washington and Oregon or Washington not categorized as Corecore or Extended Core.extended core.
We make multifamily loans on a recourse or nonrecourse basis. We may require borrowers to provide personal guarantees in a variety of circumstances, including where a borrower lacks sufficient property ownership and management experience, or where specific loan characteristics do not meet our stringent underwriting criteria, including but not limited to loans with higher loan to value ratios or lower debt service coverage ratios. Loans on other commercial real estate are generally made on a comparable basis.
Our multifamily loans typically have a 30 year30-year term, while our nonresidential commercial property loans have a 30 year30-year amortization period, and are typically due in ten years. For commercial real estate, we offer adjustable rate loans based on LIBOR or the 12 month Treasury average indices, with an adjustable rate, 5-year hybrid product being our most common multifamily loan product type. Historically, our nonresidential commercial property loans were originated primarily using the LIBOR index; however, use of this index was discontinued during 2019. We seek to have interest rates on all of our commercial loans adjust or reprice no later than seventen years after origination, and quarterly or semi-annually thereafter, but our ability to obtain this term is subject to the effects of market competition, customer preferences and other factors beyond our control.
Our multifamily loans and other commercial real estate loans are currently primarily originated on a retail basis, through the marketing efforts of our lending officersbankers and loan production offices. Prior to 2015, these loans were originated primarilyoffices, and on a wholesale basis, through a network of brokers. We intend to maintain a balance
of both retail and wholesale loan originations, as we expand into additional markets, and to tailorwhile tailoring our approach to origination of loans in each market to the characteristics of theeach particular market. While our multifamily and other commercial real estate loans are generally held in portfolio, we willmay at times sell pools of loans as a means of managing our loan product concentrations, liquidity position, capital levels and/or interest rate risk.
•Single Family Residential Lending.
Our single family residential lending provides loans for the purchase or refinance of 1-4 family residential properties. The financed properties may be owner-occupied, or investor owned, and may be a primary residence, a second home or vacation property, or an investment property.
We currently originate substantially all of our single family residential loans through a network of wholesale brokers. We monitor and regularly review our broker relationships for regulatory compliance, integrity, competence and level of activity and profitability.activity. The primary products offered are 3, 5, 7, and 7-year10-year variable rate hybrid loans and, to a 30-year fixed rate loan program, as well aslesser extent, the Grow and Daisy loansloan products described below. From 2013 until the first quarter of 2017, we originated single family residential mortgage loans on a retail basis. Through this discontinued retail channel, we offered a full range of mortgage products, including 30 year fixed rate products in addition to our portfolio hybrid products. We also brokered loans for other financial institutions, which allowed us to offer additional products. Variable rate loan production was generally held in our loan portfolio, the long-term fixed loan originations were sold to correspondents or to Federal Home Loan Mortgage Corporation, or Freddie Mac. Direct sales to Freddie Mac, on a servicing retained basis, began in late 2016.
The markets in which we make single family residential loans arehave historically been the same core and extended core markets in which we make multifamily residential and commercial real estate loans. These areas arehave been characterized by robust job markets, strong single family residential demand, high average housing cost, and concentrations of professional, highly skilled and high income workers, entrepreneurs and other high net worth individuals. These characteristics providehave provided a strong market for our jumbo mortgage products. TheseOur loans are underwritten to our financial parameters of loan to value and debt to income and debt service coverage ratios. Our underwriting includes a thorough analysis of the borrower’s ability to repay the loan, based on reviews of information regarding the borrower’s income, cash flow and wealth. This analysis enables us to provide loans to professionals, business owners and entrepreneurs who may not have a constant, readily documentable earnings stream, but substantial assets, income and wealth. Our platform and niche lending offerings are designed to meet the needs of the high demand, low supply residential real estate market in high cost market areas, and are focused on delivering consistent certainty of execution. Our single family residential loans are generally held in portfolio, although we reserve the right to sell any loan at any time.
•Grow and Daisy.
We also offer innovative mortgage products, including a portfolio 30 year30-year fixed rate first mortgage and a forgivable second mortgage to low- and moderate-income borrowers designed to make home ownership possible and affordable even in our high cost markets. Our ‘‘Grow’’ program is designed as a conventional, community lending mortgages,mortgage, up to the conforming loan limit amount, that offers underwriting flexibility to low- and moderate-income borrowers who have income of 140% or less of the area median income and meet other financial qualifications. Properties financed under the Grow program must beborrowers purchasing properties located in a low- or moderate- income census tract if the borrower’s income is 80% or more of the area’s median income.communities. Loans in this program are 30 year30-year fixed rate mortgages made on owner-occupied single family (one and two unit) properties, including condominiums, to entry level buyers.condominiums. Pricing on this product is competitive at market rate.
In conjunction with the Grow program, we also offer a down payment and closing cost assistance product, called ‘‘Daisy.’’ Under the Daisy program, eligible borrowers may take advantage of our second lien loan that provides up to two percent of the purchase price with an additional one percent for non-recurring closing costs to assist first time homebuyers when utilizing Grow, our first lien program. The loan has a term of 36 months with no payment required during the term of the Daisy loan. Daisy loans are not recorded as assets, but are instead expensed upon origination given their fully forgivable nature.
Loans under the Grow and Daisy programs help meet compelling needs in our communities, but may be associated with higher loan to value and combined loan to value ratios when compared to our standard portfolio products.
Investment Activities
Our investment securities portfolio is primarily maintained as an on-balance sheet contingent source of liquidity. It provides additional interest income and has limited interest rate risk and credit risk. Other than certain securities purchased for CRACommunity Reinvestment Act ("CRA") purposes, we generally classify all of our investment securities as available-for-sale.available for sale. Our investment policy authorizes investment primarily in U.S. Treasury securities, U.S. Agency mortgage and loan backed securities and certain CRA qualifying investments. For purposes of our investment policy, U.S. Agencies are the Small Business Administration or SBA,("SBA"), the National Credit Union Administration or NCUA,("NCUA"), the Government National Mortgage Association or GNMA, ("GNMA"), the Federal Home Loan Mortgage Corporation ("Freddie Mac, Mac"), the Federal National Mortgage Association ("Fannie Mae andMae"), the Federal Farm Credit Banks Funding Corporation.Corporation and the U.S. Department of Education (guarantee of Sallie Mae securities). Securities issued by the SBA, NCUA and GNMA are backed by the full faith and credit of the federal government.
Funding Activities
Deposits.
We offer a wide array of deposit products for individuals entrepreneurs, professionals and businesses, including interest and noninterest-bearing transaction accounts, certificates of deposit ("CD") and money market accounts. We provide a high level of customer service to our depositors. As a means of supplementing our strategically limitedlocated branch network, we offer our consumer customers unlimited free ATM access to ATM machines worldwide. Our strategy has produced a stable customerworldwide on the MoneyPass and depositor base.Allpoint networks. We have invested in personnel, business and compliance processes and technology that enable us to acquire, and efficiently and effectively serve, a wide array of business deposit accounts, while continuing to provide the level of customer service for which we are known.
known to our depositors.
Our deposits are currently acquired primarily through our branch network on a retail basis from high net worth individuals, professionals and their businesses, who value our financial strength, stability, and high level of service.service and competitive interest rates. We have expanded our focus to leverage our relationships and serve business and individuals with a broader array of deposit, card and cash management products.
We continue to increase our digital marketing presence to attract deposits within a wider geographic band surrounding our existing branch locations.
We currently offer a comprehensive range of business deposit products and services to assist with the banking needs of our business customers, from a basic reserve account (savings and CD products) to integrated operating accounts with cash management capacity. Our online banking platform allows a customer to view balances, initiate payments, pay bills (including Positive Pay) and set up custom alerts/statements. Online wires, ACH and remote capture are additional payment optionsaccount features available to qualified businesses. Our debit cards allow access to cash nationwideworldwide as a result of our membership in major ATM networks. We also provide online and mobile banking products to our consumer depositors, to complement our branch network.
We plan to continue to grow our deposits by cross-selling business deposit relationships to our existing consumer customers who are business owners, and consumer and business accounts to our multifamily and single family loan borrowers through selective establishment of new branches in key markets of California and Washington, and by obtaining new individual and business customers, including specialty deposit customers, such as escrow and title company depositors andfiduciary services providers, 1031 exchange companies.companies, unions and nonprofits. Our cross-selling efforts to existing customers will beare strategically targeted, based on our in depth analyses of our customers’ overall financial situation, global cash flows, financial resources and banking requirements. Our cross-selling efforts are in their very early stages, and weWe believe there is a significantadditional capacity to expand deposit and lending relationships on this basis.
We supplement customer deposits with wholesale, or brokered, deposits where necessary to fund loan demand prior to raising additional customer deposits, or where desirable from a cost or liability maturity standpoint. Our current policy limits the use of wholesale deposits in accordance with our risk appetite level as determined by our board of directors.
Our reliance on brokered deposits increased during 2022 given the rapid rise in interest rates and the competitive environment for generating retail deposits.
Borrowings.
We supplement the funding provided by our deposit accounts with other borrowings at the Bank level from the Federal Home Loan Bank of San Francisco ("FHLB") to enable us to fund loans and to meet liquidity needs. We also maintain a line of credit at the FRBFederal Reserve Bank of San Francisco ("FRB") Discount Window, which other than periodic testing, is generally not used.used but provides an additional source of funding, if necessary. The use of FHLB borrowings can vary significantly from period to period, as the ability to originate loans frequently outpacesmay outpace the ability to obtain core deposits at acceptable rates and in comparable amounts.
Risk Management
We believe that effective risk management is of primary importance. Risk management refers to the activities by which we identify, measure, monitor, evaluate and manage the risks we face in the course of our banking activities. These include liquidity, interest rate, credit, operational, compliance, regulatory, strategic, financial and reputational risk exposures. Our board of directors and management team have created a risk-conscious culture that is focused on quality growth, which starts with capable and experienced risk management teams and infrastructure capable of addressing the evolving risks we face, as well as the changing regulatory and compliance landscape. Our risk management approach employs comprehensive policies and processes to establish robust governance and emphasizes personal ownership and accountability for risk with all our employees. We believe a disciplined and conservative underwriting approach has been the key to our strong asset quality.
Our board of directors sets the tone at the top of our organization, adopting and overseeing the implementation of our Bank’s risk management framework, which establishes our overall risk appetite and risk management strategy. The board of directors approves our Risk Appetite Statement, which includes risk policies, procedures, limits, targets and reporting, structured to guide decisions regarding the appropriate balance between risk and return considerations in our business. Our board of directors receives periodic reporting on the risks and control environment effectiveness and monitors risk levels in relation to the approved risk appetite. The Audit & Risk Committee of our board of directors provides oversight of all enterprise risk management. The Executive Committee of management is charged with identifying, managing and controlling key risks that threaten our ability to achieve our strategic initiatives and goals.
Credit risk is the risk that borrowers or counterparties will be unable or unwilling to repay their obligations in accordance with the underlying contractual terms and the risk that credit assetscollateral will suffer significant deterioration in market value. We manage and control credit risk in our loan portfolio by adhering to well-defined underwriting criteria and account administration standards established by management and approved by the board of directors. Written credit policies document underwriting standards, approval levels, exposure limits and other limits or standards deemed necessary and prudent. Portfolio diversification at the obligor, product and geographic levels is actively managed to mitigate concentration risk. In addition, credit risk management includes an independent credit review process that assesses compliance with commercial real estate and consumer credit policies, risk rating standards and other critical credit information. In addition to implementing risk management practices that are based upon established and sound lending practices, we adhere to sound credit principles. We understand and evaluate our customers’ borrowing needs and capacity to repay, in conjunction with their character and history. The Bank’s Credit Council, which includes our President and Chief Executive Officer, our Chief Credit Officer, Chief Financial Officer and Chief Risk Officer, is responsible for ensuring that the Bank has an effective credit risk management program and credit risk rating system, adheres to our board’s Risk Appetite Statement, and maintains an adequate allowance for loan losses. Our management and board of directors place significant focus on
maintaining a healthy risk profile and ensuring sustainable growth. Our risk appetite seeks to balance the risks necessary to achieve our strategic goals while ensuring that our risks are appropriately managed and remain within our defined limits.
Our management of interest rate and liquidity risk is overseen by our Asset and Liability Council, which is chaired by our Chief Financial Officer, based on a risk management infrastructure approved by our board of directors that outlines reporting and measurement requirements. In particular, this infrastructure reviews financial performance, trends, and significant variances to budget; reviews and recommends for board approval risk limits and tolerances; reviews ongoing monitoring and reporting regarding our performance with respect to these areas of risk, including compliance with board-approved risk limits and stress-testing; reviews and recommends to the Executive Committee for approval any changes to theories, mathematics, methodologies, assumptions, and data output for models used to measure these risks; ensures annual back-testing and independent validation of models at a frequency commensurate with risk level; reviews all hedging strategies and recommends changes as appropriate; reviews and recommends our contingency funding plan; recommends to the Executive Committee proposed wholesale borrowing limits to be submitted to the board of directors or its designated committee; recommends to the Executive Committee the proposed terms of any newunanticipated long-term borrowing arrangement prior to debt issuance; develops recommended capital requirements; and acts as a second line of defense in reviewingreviews information and reports submitted to thethis council for the purpose of identifying, investigating, and assuring remediation to its satisfaction, of errors or irregularities, if any.
Our investment portfolio is generally comprised of government agency securities defined by Basel III as high-quality liquid investments. The portfolio is primarily maintained to serve as a contingent, on-balance sheet source of liquidity to fund loans and meet the demands of depositors, and as such, is kept unencumbered. 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 which is reflective in the yields obtained on those securities. Most of our securities as classified as available-for-sale, although we occasionally purchase long-term fixed rate mortgage backed securities or municipal securities for community reinvestment purposes and classify those as held-to-maturity.
any potential issues.
Internet Access to Company Documents
The Company provides access to its Securities and Exchange Commission ("SEC")SEC filings through its web site at www.lutherburbanksavings.com. After accessing the web site,website, the filings are available upon selecting "About Us/Investor Relations/Financials/SEC Filings." Reports available include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed with or furnished to the SEC.
Further, the SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. All website addresses given in this document are for information only and are not intended to be an active link or to incorporate any website information into this document.
Luther Burbank Corporation Foundation
Following the recent northern California wildfires,In 2017, we established the Luther Burbank Corporation Foundation ("Foundation") which was granted 501(c)(3) status by the IRS.Internal Revenue Service ("IRS"). The Foundation is an all-volunteer organization having no paid staff and will primarily be funded by Luther Burbank Corporation,the Company, as well as from our directors business partners and a corporate giving program recently implemented that will matchmatches employee donations. Grants disbursed from theThe Foundation will consist of providing disaster relief and rebuilding assistancefocuses its activities in and around Santa Rosa following the wildfires as well as making all of its grants that qualify for the Community Reinvestment Act, inour communities on the three priority areas of (1) social and human services; (2) community development; and (3) education.
EmployeesHuman Capital
As of December 31, 2017,2022 and 2021, we had 258 full-time256 and 281 employees, and 8 part-time employees. Nonerespectively, nearly all of whom are full-time. As a financial institution, approximately 27% of our employees is covered by a collective bargaining agreement. We considerare employed at our relationship withbranch and loan production offices. The remaining portion of our employees generally work from our administrative offices in Northern and Southern California. Our business is highly dependent on the success of our employees, who provide value to beour customers and communities through their dedication to our mission, which is "to improve your financial future with a superior human-centered experience - whether you are a customer, employee, or shareholder." Our core values are based on acting ethically and with integrity to provide superior service to our customers and each other with the goal of achieving our mantra that “you’re worth more here.” To further promote our core values, we acknowledge and reward employees throughout the year that exemplify these values.
We seek to hire well-qualified employees who are also a good fit for our value system. In 2022 and have not experienced interruptions2021, 34% and 44%, respectively, of operations dueour new hires were from an employee referral. During the years ended December 31, 2022 and 2021, our employee voluntary turnover ratios were 23% and 16%, respectively. As of December 31, 2022 and 2021, 59% and 52%, respectively, of our employees were employed with us for five years or longer. Our selection and promotion processes are without bias and include the active recruitment of minorities and women. During the years ended December 31, 2022 and 2021, individuals from underrepresented groups filled 65% and 61%, respectively, of the Company's promotions and hirings. As of December 31, 2022, women represented 67% of our workforce and 43% of our executive management team. As of December 31, 2022, the population of our workforce, based on employee self-reported information or Human Resources’ observation, was as follows:
(a) Minorities are defined as all U.S. Equal Employment Opportunity Commission categories other than white.
We strive to labor disagreements.provide a competitive compensation and benefits program to help meet the needs of our employees. In addition to salaries, these programs include incentive compensation plans, stock awards, a 401(k) Plan with an employer matching contribution, healthcare and insurance benefits, health savings and flexible spending accounts, paid time off, family leave and an employee assistance program.
Item 1A. Risk Factors
We
In the course of our business operations, we are subjectexposed to numerous risks, some of which are inherent in the financial services industry and others of which are more specific to our own business. The discussion below addresses the material factors, of which we are currently aware, that could affect our business, results of operations and/or financial condition. The risk factors below should not be considered a complete list of potential risks and uncertainties that management believes affect us arewe may face. Any risk factor described below. Anyin this Form 10-K or in any of these risks, if they are realized,our SEC filings could by itself, or together with other factors, materially adversely affect our business, financial condition, andliquidity, competitive position, reputation, results of operations, and consequently, the value ofcapital position or financial condition, including by materially increasing our common stock. Additional risks and uncertainties not currently known to usexpenses or that we currently believe to be immaterial may also materially and adversely affect us. As adecreasing our revenues, which could result the trading price of our common stock could decline and you could lose all or part of your investment.in material losses.
Some statements in these risk factors constitute forward-looking statements that involve risks and uncertainties. Please refer to the section entitled "Cautionary Note Regarding Forward-Looking Statements."
Risks RelatedInterest Rate Risk
We are subject to interest rate risk, which could adversely affect our profitability.Our Businessprofitability, like that of most financial institutions, depends to a large extent on our net interest income, which is the difference between our interest income on interest-earning assets, such as loans and investment securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowings.
Historically, we have been, and, as of December 31, 2022, we remain, a liability-sensitive institution, which means when short-term interest rates rise, the rate of interest we pay on our interest-bearing liabilities, such as deposits, may rise more quickly than the rate of interest that we receive on our interest-earning assets, such as loans, which may cause our net interest income to decrease. This was the case in 2022, when the Board of Governors of the Federal Reserve System (“Federal Reserve”), significantly increased interest rates and the benchmark rate at an unprecedented pace, and as a result, our weighted average cost of interest-bearing liabilities increased from 0.73% during the quarter ended December 31, 2021 to 2.15% during the quarter ended December 31, 2022, while at the same time our weighted average yield on interest-earning assets only increased from 3.23% during the quarter ended December 31, 2021 to 4.00% during the quarter ended December 31, 2022, resulting in a decrease in our net interest margin from 2.57% to 2.01% for the quarters ended December 31, 2021 and 2022, respectively. Additional repricing in our interest-bearing liabilities as a result of past interest rate increases and any further Federal Reserve increases in interest rates and the benchmark rate may negatively affect our net interest income.
Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular and as described above, the Federal Reserve. Changes in monetary policy, including changes in interest rates, influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes also affect our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our assets. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial,
unexpected, prolonged or rapid change in market interest rates could have a material adverse impact on our business, financial condition and results of operations.Additionally, a shrinking yield premium between short-term and long-term market interest rates, a pattern typically indicative of investors' waning expectations of future growth and inflation, commonly referred to as a flattening of the yield curve, as well as an inverted yield curve, where long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality, typically reduce our profit margin since we borrow at shorter terms than the terms at which we lend and invest.
An increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay current loan obligations. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs, but also reduce collateral values and necessitate further increases to the allowance for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
Liquidity Risk
Liquidity risk could impair our ability to fund operations and meet our obligations as they become due and failure to maintain sufficient liquidity could materially adversely affect our growth, business, profitability and financial condition. Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding at a reasonable cost, in a timely manner and without adverse conditions or consequences. We require sufficient liquidity to fund asset growth, meet customer loan requests, satisfy customer deposit withdrawals at maturity and on demand, make payments on our debt obligations as they come due and satisfy other cash commitments under both normal operating conditions and other challenging or unpredictable circumstances, including events causing industry or general financial market stress. To fund our operations, we rely on customer deposits, advances from the FHLB, which is one of eleven banks in the Federal Home Loan Bank system ("FHLB System"), brokered deposits, occasional loan sales and, to a lesser extent, advances from the FRB.
Liquidity risk, which includes our ability to access liquidity sources such as customer deposits, advances from the FHLB and FRB, and brokered deposits, can increase due to a number of factors, including: adverse changes in our financial condition or performance or in our CRA rating; a decrease in the level of our deposit activity, including as a result of customers moving funds into higher yielding assets or changes in the liquidity needs of our depositors; adverse regulatory actions against us; an over-reliance on a particular source of funding; the financial condition of the FRB, FHLB and the FHLB System; and market-wide phenomena such as market dislocation and major disasters.
As of December 31, 2022, we estimated that $1.3 billion of our deposits exceeded the insurance limits established by the FDIC. None of our deposits are governmental deposits secured by collateral. Our inability to retain and raise funds, or inability to retain and raise funds on competitive terms, through deposits, FHLB and FRB borrowings, the sale of loans, and other sources could have a substantial negative effect on our ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity, including as a result of the rapidly rising interest rates in 2022 and any future increase in interest rates, could impair our ability to fund operations and meet our obligations as they become due (including our senior notes due in September 2024 with a balance of $95 million at December 31, 2022); could have a material adverse effect on our business, financial condition and results of operations; and could result in the closure of the Bank.
We may not be able to retain or grow our core deposit base, which could adversely impact our funding costs. We rely on customer deposits as our primary source of funding for our lending activities, and we continue to seek customer deposits to maintain this funding base. Our financial condition and financial performance largely depend on our ability to maintain our deposit base in a profitable manner. Customer deposits are subject to potentially dramatic fluctuations in availability or price due to various factors, most of which are outside of our control, such as increasing competitive pressures, changes in interest rates and returns on other investment classes, customer perceptions of our financial health and general reputation, or a loss of confidence by customers in us or the banking sector generally, which could result in significant outflows of deposits within short periods of time or significant changes in pricing or other terms necessary to maintain current customer deposits or attract additional deposits.
Our deposit customers tend to be more interest-rate sensitive than customers at some competitor banks, which means our deposit customers may be more likely to move funds into higher-yielding investment alternatives than deposit customers at some of our competitor banks. The recent rapidly rising interest rate environment and resulting
competition for deposits has made it challenging for us to attract and retain certain deposit customers and maintain our profitability, which in turn has resulted in lower margins. Additional repricing in our interest-bearing liabilities as a result of past interest rate increases as well as future interest rate increases and/or a prolonged high interest rate environment could result in decreased loan originations and margins, which could have a material adverse effect on our business, financial condition and results of operations.
Economic and Market Conditions Risk
Our business and operations may be materially adversely affected by weak or uncertain economic conditions.
Our business and operations, which primarily consist of banking activities, including lending money to customers in the form of real estate secured loans and borrowing money from customers in the form of deposits, are sensitive to general business and economic conditions in the U.S. generally, and on the West Coast in particular. The economic conditions in our local marketsparticular, which may be differentdiffer from the economic conditions in the U.S. as a whole. If economic conditions in the U.S. or any of our markets weaken, our growth and profitability from our operations could be constrained. In addition, foreign economic and political conditions could affect the stability of global financial markets, which could hinder economic growth. The current economic environment is characterized by interest rates near historically low levels, which impact our ability to attract deposits and to generate attractive earnings through our loan and investment portfolios. All these factors can individually or in the aggregate be detrimental to our business, and the interplay between these factors can be complex and unpredictable. Unfavorable market conditions can result in a deterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of delinquencies, defaults and charge-offs, additional provisions for loan losses, a decline in the value of our collateral, and an overall material adverse effect on the quality of our loan portfolio.
Our business is also significantly affected by monetary and related policies of the U.S. federal government and its agencies. Uncertainty about the federal fiscal policymaking process, the medium and long-term fiscal outlook of the federal government, and future tax rates are concerns for businesses, consumers and investors in the U.S. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse and uncertain economic conditions caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences including, but not limited to, the conflict in Ukraine and related developments, the COVID-19 pandemic or other pandemics, unemployment, changes in securities markets, declines in home values, ineffective management of the U.S. Federal budget or debt, a tightening credit environment or other factors, and U.S. and foreign government policy responses to such conditions could have a material adverse effect on our business, financial conditions and results of operations.
We are subjectincluding, but not limited to, interest rate risk, which could adversely affect our profitability.
Our profitability, like that of most financial institutions, depends to a large extent on our net interest income, which is the difference between our interest income on interest-earning assets, such as loans and investment securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowings.
Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System, or the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes could affect our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our assets. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected or prolonged change in market interest rates could have a material adverse impact on our business, financial condition and results of operations.
Our interest sensitivity profile was liability sensitive as of December 31, 2017. When short-term interest rates rise, the rate of interest we pay on our interest-bearing liabilities, such as deposits, may rise more quickly than the rate of interest that we receive on our interest-earning assets, such as loans, which may cause our net interest income to decrease. Additionally, a shrinking yield premium between short-term and long-term market interest rates, a pattern typically indicative of investors' waning expectations of future growth and inflation, commonly referred to as a flattening
of the yield curve, typically reduces our profit margin as we borrow at shorter terms than the terms at which we lend and invest.
In addition, an increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs, but also reduce collateral values and necessitate further increases to the allowance for loan losses, whichsanctions, could have a material adverse effect on our business, financial condition and results of operations. For example, the rapid and significant increase in interest rates during 2022 combined with historically below average real estate inventory levels have decreased demand for the Company’s real estate loan products. Real estate refinance activity and loan payoffs are strongly correlated with changes in mortgage interest rates. Rising mortgage rates during the last year resulted in fewer loan payoffs and had an adverse impact on the Company’s business, which conditions are expected to continue for so long as mortgage rates continue to rise or if they subsequently remain high relative to the interest rates of outstanding mortgages.
The replacement of the LIBOR benchmark interest rate may adversely affect our results of operations. We have financial instruments that are priced based on variable interest rates tied to LIBOR. On July 27, 2017, the United Kingdom’s Financial Conduct Authority (“FCA”) announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. On November 30, 2020, to facilitate an orderly LIBOR transition, the Office of the Comptroller of the Currency ("OCC"), the Federal Deposit Insurance Corporation ("FDIC"), and the Federal Reserve jointly announced that entering into new contacts using LIBOR as a reference rate after December 31, 2021 would create a safety and soundness risk. On March 5, 2021, the FCA announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after December 31, 2021, in the case of 1-week and 2-month U.S. dollar LIBOR, and immediately after June 30, 2023, in the case of the remaining U.S. dollar LIBOR settings. In the United States, efforts to identify a set of alternative U.S. dollar reference interest rates are ongoing, and the Alternative Reference Rate Committee (“ARRC”) has recommended the use of the Secured Overnight Financing Rate ("SOFR"). SOFR is different from LIBOR in that it is a secured rate rather than an unsecured rate. This difference could lead to a greater disconnect between our ability to make loans using SOFR and our costs to raise funds for SOFR as compared to LIBOR. For cash products and loans, the ARRC has recommended Term SOFR with a credit spread, which is a forward-looking SOFR based on SOFR futures and may in part reduce differences between SOFR and LIBOR.
As of December 31, 2022, we had $529.2 million of loans, $245.3 million of investments, $61.9 million of junior subordinated deferrable interest debentures and $15.9 million of other assets that were indexed to LIBOR. There are also operational issues which may create a delay in the transition to SOFR or other substitute indices, leading to uncertainty across the industry. The implementation of a substitute index or indices, or the use of a fixed interest rate, for the calculation of interest rates under our financial instruments may cause significant expenses in effecting the transition, may result in reduced loan balances if our borrowers do not accept the substitute index or indices, may result in increased expenses if holders of the junior subordinated deferrable interest debentures or other counterparties to our financial instruments do not accept a substitute index or indices, or attempt to establish a fixed interest rate, and may result in disputes or litigation with customers, trustees or noteholders over the appropriateness or comparability to LIBOR of the substitute index or indices or other interest rate calculations, which could have an adverse effect on our results of operations. These consequences cannot be entirely predicted and could have an adverse impact on the market value for or value of LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us.
Credit Risk
We are subject to credit risk, which could adversely affectimpact our profitability.
Our business depends on our ability to successfully measure and manage credit risk. As a lender, we are exposed to the risk that the principal of, or interest on, a loan will not be paid timely or at all or that the value of any collateral supporting a loan will be insufficient to cover our outstanding exposure. In addition, we are exposed to risks with respect to the period of time over which the loan may be repaid, risks relating to loan underwriting, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual loans and borrowers. The creditworthiness of a borrower is affected by many factors including local market conditions and general economic conditions. If the overall economic climate in the U.S., generally, or in our market areas specifically, experiences material disruption, our borrowers may experience difficulties in repaying their loans, the collateral we hold may decrease in value or become illiquid, and the level of nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for loan losses. Additional factors related to the credit quality of multifamily residential and other commercial real estate (“CRE”) loans include the quality of management of the business, and tenant vacancy rates.
rates, rent control regulations, eviction moratoriums and limitations, and economic conditions that may have a disparate impact on some tenants of properties within this portfolio, many of which are low or moderate income tenants or small businesses.
Our risk management practices, such as monitoring the concentration of our loans within specific markets and product types and our credit approval, review and administrative practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic, employment or any other conditions affecting customers and the quality of the loan portfolio. Many of our loans are made to individuals or small businesses that are less able to withstand competitive, economic and financial pressures than larger borrowers.businesses. Consequently, we may have significant exposure if any of these borrowers becomesbecome unable to pay their loan obligations as a result of economic or market conditions, or personal circumstances, such as divorce, unemployment or death. A failure to effectively measure and limit the credit risk associated with our loan portfolio may result in loan defaults, foreclosures and additional charge-offs, and may necessitate that we significantly increase our allowance for loan losses, each of which could adversely affect our net income. No matter how effectively we measure and limit such credit risk, we may still experience certain negative consequences during economic downturns, especially when such downturns are either severe or prolonged or when unemployment is high. As a result, our inability to successfully manage credit risk could have a material adverse effect on our business, financial condition and results of operations.
Our multifamily residential and other commercial real estate loan portfolios generallymay carry greatersignificant credit risk than loans secured by our other mortgage loans.
risk.Our loan portfolio consists primarily of multifamily residential and, to a lesser extent, other commercial real estateCRE loans, which are primarily secured by industrial, office and retail properties. As of December 31, 2017,2022, our multifamily residential loans totaled $2.9$4.5 billion, or 57.8%64.7%, of our loan portfolio, and our other commercial real estateCRE loans totaled $112.5$172.3 million, or 2.3%2.5% of our loan portfolio. Nonperforming multifamily residential loans were $2.2$3.5 million and nonperforming other commercial real estate loans were $656 thousand at December 31, 2017.2022. There were no nonperforming other CRE loans at December 31, 2022. Multifamily residential and commercial real estateother CRE loans may carry more risk as compared to single family residential lending, because they typicallythat involve largerlarge loan balances concentrated with a single borrower or groups of related borrowers. In addition, these loans expose a lender to greaterborrowers may carry significant credit risk than those secured by residential real estate.risk. The payment on thesemultifamily residential and other CRE loans that are secured by income producingincome-producing properties are typically dependent on the successful operation of the related real estate property and may subject us to risks from adverse conditions in the real estate market or the general economy. Investment in these properties by our customers is influenced by prices and return on investment, as well as changes to applicable laws regarding, among other things, rent control, moratoriums or limitations on evictions for non-payment, personal and corporate tax reform, pass-through rules, immigration and fiscal and economic policy. The collateral securing these loans, typically cannotparticularly CRE loans, may not be liquidated as easily as single family residential (“SFR”) real estate during economic downturns or other unfavorable conditions, which may lead to longer holding periods as compared to single family residential properties.
periods. If these properties become less attractive investments, demand for our loans would decrease. In addition, unexpected deterioration in the credit quality of our multifamily residential or commercial real estateother CRE loan portfolios could require us to increase our provisionallowance for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.
Our allowance for loan losses may be inadequate to absorb probable incurred losses inherent in the loan portfolio, which could have a material adverse effect on our business, financial condition and results of operations. We periodically review our allowance for loan losses for adequacy considering historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accrual loans, economic conditions and other pertinent information. The determination of the appropriate level of the allowance for loan losses is inherently highly subjective and requires us to make significant estimates of and assumptions regarding current credit risk and future trends, all of which may change materially. These estimates of loan losses are necessarily subjective and their accuracy depends on the outcome of future events. Inaccurate
management assumptions, deterioration of economic conditions affecting borrowers, declines in real estate values, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses. In addition, our regulators periodically review our loan portfolio and the adequacy of our allowance for loan losses and may require adjustments based upon judgments that are different than those of management. Differences between our actual experience and assumptions and the effectiveness of our models could adversely affect our business, financial condition and results of operations.
Further impacting the sufficiency of our current allowance for loan losses is the implementation of the Current Expected Credit Losses ("CECL") allowance methodology, which we adopted on January 1, 2023. The CECL methodology depends on future economic forecasts, assumptions and models that are inherently uncertain and may prove to be inaccurate and could result in increases in, and add volatility to, our allowance for loan losses and future provisions for loan losses.
Lack of seasoning of our loan portfolio could increase risk of credit defaults in the future. As a result of our organic growth over the past several years, as of December 31, 2022, approximately $4.5 billion, or 63.9% of the loans in our loan portfolio were originated since January 1, 2019, excluding in-house refinancings. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as "seasoning." As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Therefore, since a large portion of our loan portfolio is relatively new, the current level of delinquencies and defaults may not represent the level that may prevail as the portfolio becomes more seasoned and may not serve as a reliable basis for predicting the health and nature of our loan portfolio, including net charge-offs and the ratio of nonperforming assets in the future. Our limited experience with these loans does not provide us with a significant history pattern with which to judge future collectability or performance. Our credit underwriting process, our ongoing credit review processes, and our management of our loan portfolio may not be adequate to mitigate these risks. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
Our SFR loan portfolio possesses increased risk due to our level of non-conforming loans. Many of the SFR mortgage loans we have originated consist of loans that do not conform to Fannie Mae or Freddie Mac underwriting guidelines as a result of loan terms, loan size, or other exceptions from agency underwriting guidelines. Additionally, many of our loans do not meet the qualified mortgage (“QM”) definition established by the Consumer Financial Protection Bureau (“CFPB”), and, therefore, contain additional regulatory and legal risks. In addition, the secondary market demand for non-conforming and non-QM mortgage loans is generally limited, and consequently, we may experience difficulties selling non-conforming loans in our portfolio should we decide to do so.
We are exposed to higher credit risk due to relationship exposure with a number of large borrowers. As of December 31, 2022, we had 28 borrowing relationships in excess of $20 million which accounted for approximately 15.6% of our loan portfolio. These borrower relationships had an average of 12 loans outstanding per relationship. A deterioration of any of these credit relationships could require us to increase our allowance for loan losses or result in significant losses to us, which could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to the Merger
The consummation of the recently-announced merger with WAFD is contingent upon the satisfaction of a number of conditions, including shareholder and regulatory approvals, that may be outside of our control and that we may be unable to satisfy or obtain or which may delay the consummation of the merger or result in the imposition of conditions that could cause the parties to abandon the merger. As noted in Note 1 in Part II - Item 8. "Notes to Consolidated Financial Statements”, on November 13, 2022, the Company and WAFD entered into the Merger Agreement, pursuant to which, and subject to the terms and conditions of the Merger Agreement, the Company will merge with and into WAFD, with WAFD as the surviving institution, promptly followed by the merger of Luther Burbank Savings with and into Washington Federal Bank, dba WaFd Bank, with WAFD Bank as the surviving institution (collectively, the “Merger”).
Before the transactions contemplated in the Merger Agreement can be completed, approvals must be obtained from regulatory authorities, shareholders and other customary closing conditions must have been satisfied or waived. The required regulatory approvals may require changes to the terms of the transactions contemplated by the Merger Agreement. There can be no assurance that our or WAFD’s regulators will not impose any additional conditions, limitations, obligations or restrictions on the parties, or that they will not have the effect of delaying or
preventing the completion of the Merger, imposing additional material costs on or materially limiting the revenues of the surviving entity following the Merger or otherwise reducing the anticipated benefits of the Merger.
Uncertainties about the effect of the Merger may impair our ability to attract, retain and motivate key personnel until the Merger is consummated and for a period of time thereafter, and could cause customers and others that deal with us to seek to change their existing business relationships with us. It is not unusual for competitors to use mergers as an opportunity to target the merging parties’ customers and to hire certain of their employees. Employee retention may be particularly challenging during the pendency of the Merger, as employees may experience uncertainty about their roles with the surviving entity following the Merger.
The Merger Agreement contains provisions that restrict our ability to, among other things, initiate, solicit, knowingly encourage or knowingly facilitate, inquiries or proposals with respect to, or, subject to certain exceptions generally related to our Board of Directors’ exercise of fiduciary duties, engage in any negotiations concerning, or provide any confidential information relating to, any alternative acquisition proposals. These provisions, which include payment of a termination fee of $26.17 million (the “Termination Fee”) payable to WAFD, which, under certain circumstances, may discourage any potential competing acquirer having an interest in acquiring us from proposing a transaction, or may result in the offer of a lower per share price to acquire us than might otherwise have been proposed.
The value to be recognized by our shareholders from the Merger is subject to material uncertainties. The Merger Agreement provides that upon the closing of the Merger our shareholders will receive per share of common stock of Luther Burbank, 0.3353 shares of common stock, par value $1.00 per share, of WAFD and cash in lieu of fractional shares of WAFD common stock. The exchange ratio for the conversion of our common stock into common stock of WAFD (“WAFD Common Stock”) was set based upon information available to the boards of directors and financial advisors of each company at the time the Merger Agreement was entered into. The market price of our common stock and of WAFD Common Stock fluctuates constantly in response to a variety of factors that are inherently unpredictable and outside of our control, including changes in our and WAFD’s business, operations and prospects, and regulatory considerations, the historical and anticipated future financial results of our respective banking operations and general market and economic developments affecting the United States and international businesses and financial markets. The substantial differences between our business and the business of WAFD will subject our shareholders to new and different risks than those with which they are familiar with our business.Aperiod of months may transpire between the date that our shareholders are asked to approve the Merger and the earliest date the Merger can be closed, during which time the price of the Company’s common stock and WAFD Common Stock will continue to fluctuate and WAFD’s adjusted shareholders’ equity may continue to fluctuate. As a result, at the time that our shareholders must decide whether to approve the Merger Agreement, they may not necessarily know the precise value of the merger consideration they will receive, which could be materially different than the value of the merger consideration at the closing of the Merger.
Failure to complete the proposed Merger could negatively impact our business, financial results and stock price. If the proposed Merger is not completed for any reason, our ongoing business may be adversely affected and, without realizing any of the benefits of having completed the Merger, we would be subject to a number of related risks, including the following:
•We may be required, under certain circumstances, to pay WAFD the termination fee under the Merger Agreement, which may adversely affect our financial performance and the price of our common stock;
•We will have incurred substantial expenses and will be required to pay significant costs relating to the Merger, whether or not it is completed, such as legal, accounting, due diligence, financial advisor and printing fees;
•The Merger Agreement places certain restrictions on the conduct of our business prior to completion of the Merger, which may adversely affect our ability to execute certain of our business strategies and cause certain other projects to be delayed or abandoned;
•Matters relating to the Merger require substantial commitments of time and resources by our management team that could have been devoted to the pursuit of other opportunities beneficial to us as an independent company; and
•We may be subject to negative reactions from the financial markets and from our customers and employees that could materially affect our business, financial results and stock price; and the market price of our common stock could decline to the extent that current market prices of our common stock reflect a market assumption that the Merger will be completed.
Litigation could prevent or delay the closing of the proposed Merger or otherwise negatively impact our business and operations. We may be subject to legal proceedings related to the agreed terms of the proposed Merger, the manner in which the Merger was considered and approved by our board of directors or any failure to complete the Merger or perform our obligations under the Merger Agreement. Such litigation, regardless of the merits, could delay or block the consummation of the Merger, have an adverse effect on our financial condition and impose material costs on us or the surviving entity. One of the conditions to the closing of the Merger is that no regulation, judgment, decree, injunction or other order of a governmental authority (including any federal, state or local court or administrative or regulatory agency) which prohibits the consummation of the Merger be in effect. If any plaintiff were successful in obtaining an injunction prohibiting us or WAFD from completing the Merger on the agreed upon terms, then such injunction may prevent the Merger from becoming effective or from becoming effective within the expected timeframe.
Geographic Concentration and Climate Risk
Our business and operations are concentrated in California and Washington, and we are more sensitive than our more geographically diversified competitors to adverse changes in the local economy.
Unlike many of our larger competitors that maintain significant operations located outside our market areas, substantially all of our customers are individuals and businesses located and doing business in the statestates of California.California and Washington. As of December 31, 2017,2022, approximately 88% of the loans in our portfolio measured by dollar amount were secured by collateral located in California and 12%9% of the loans in our portfolio measured by dollar amount were secured by collateral located in Washington. In addition, 49%61% of our real estate loans measured by dollar amount, were secured by collateral located in Los Angeles County and Orange County.southern California counties. Therefore, our success will depend upon the general economic conditions in these areas, including the strength of the rental and residential purchase markets, which we cannot predict with certainty. As a result, our operations and profitability may be more adversely affected by a local economic downturn in these areas than those of large, more geographically diverse competitors. A downturn in the local economy could make it more difficult for our borrowers to repay their loans and may lead to loan losses that are not offset by operations in other markets; it may also reduce the ability of depositors to make or maintain deposits with us. For these reasons, any regional or local economic downturn could have a material adverse effect on our business, financial condition and results of operations.
Our ability to conduct our business could be disrupted by natural or man-made disasters.
disasters, severe weather events, health crises or other catastrophic events.A significant number of our offices, and a significant portion of the real estate securing loans we make, and our borrowers' business operations in general, are located in California. California has had and will continue to have major earthquakes in areas where a significant portion of the collateral and assets of our borrowers are concentrated. California is also prone to natural and climate-related disasters, including fires, mudslides, floods, droughts and other disasters. Our other locations and places where we do business are also subject to natural disasters such as the firesand severe weather events. The policies and procedures we have implemented to monitor and mitigate these risks, specifically flood and wildfire risk, in the fall of 2017 that impacted numerous areas throughout California, including Santa Rosa, the location of our corporate headquarters and our main banking office.loan portfolio may prove inadequate. Additionally, acts of terrorism, war, civil unrest, violence, or other man-made disasters, as well as energy shortages, water shortages and health crises, such as the COVID-19 pandemic, and governmental responses to those events have caused and could also cause disruptions to our business or to the economy as a whole.economies where we do business. The occurrence of natural or man-madethese disasters and other events, and governmental responses thereto, could destroy, or cause a decline in the value of, mortgaged properties or other assets that serve as our collateral andcollateral; increase the risk of delinquencies, defaults, foreclosures and losses on our loans,loans; damage our banking facilities and offices,offices; negatively impact regional economic conditions in our markets; result in a decline in loan demand and loan originations,originations; result in drawdowns of and/or fewer deposits by customers impacted by disasterscustomers; and negatively impact the implementation of our growth strategy.
We have implemented a disaster recovery and business continuity plan that allowsis designed to allow us to move critical functions to a backup data center in the event of a catastrophe. Although this program is tested periodically, we cannot guarantee its effectivenessit may not be effective in any disaster scenarios.an actual disaster. Regardless of the effectiveness of our disaster recovery and business continuity plan, the occurrence of any natural or man-made disaster, severe weather conditions, health crises or other events could have a material adverse effect on our business, financial condition and results of operations.
Climate change could have a material negative impact on the Company and customers. The Company’s business, as well as the operations and activities of our customers, could be negatively impacted by climate change. Climate change presents both immediate and long-term risks to the Company and its customers, and these risks are expected to increase over time. Climate change presents multi-faceted risks, including: operational risk from the physical effects of climate events on the Company and its customers’ facilities and other assets; credit risk from borrowers with significant exposure to climate risk; transition risks associated with the transition to a less carbon-dependent economy; and reputational risk from stakeholder concerns about our practices related to climate change and the Company’s carbon footprint.
We operate in a highly competitive market
Federal and face increasing competition from a variety of traditionalstate banking regulators and new financial services providers, which could adversely impact our profitability.
Wesupervisory authorities, investors, and other stakeholders have many competitors. Our principal competitors are commercial and community banks, credit unions, savings and loan associations, mortgage banking firms and online mortgage lenders, including large nationalincreasingly viewed financial institutions that operateas important in our market area. Many of these competitors are larger than us, have significantly more resourceshelping to address the risks related to climate change both directly and greater brand recognition than we do, andwith respect to their customers, which may be able to attract customers more effectively than we can. We compete with these otherresult in financial institutions bothcoming under increased pressure regarding the disclosure and management of their climate risks and related lending and investment activities. Given that climate change could impose systemic risks upon the financial sector, either via disruptions in attracting depositseconomic activity resulting from the physical impacts of climate change or changes in policies as the economy transitions to a less carbon-intensive environment, the Company may face regulatory risk of increasing focus on the Company’s resilience to climate-related risks, including in the context of stress testing for various climate stress scenarios. Ongoing legislative or regulatory uncertainties and changes regarding climate risk management and practices may result in higher regulatory, compliance, credit, and reputational risks and costs.
Although we have made efforts to enhance our governance of climate change-related risks and integrate climate considerations into our risk governance framework, such efforts may prove to be inadequate. Nonetheless, the risks associated with climate change are rapidly changing and evolving in an escalating fashion, making loans.them difficult to assess due to limited data and other uncertainties. We expect competition to continue to increasecould experience increased expenses resulting from strategic planning, litigation, and technology and market changes, and reputational harm as a result of legislative,negative public sentiment, regulatory scrutiny, and technological changesreduced investor and stakeholder confidence due to our response to climate change and our climate change strategy, which, in turn, could have a material negative impact on our business, results of operations, and financial condition.
Operational Risk
Operational risks are inherent in our business. Operational risks and losses can result from internal and external fraud; gaps or weaknesses in our risk management or internal control procedures; errors by employees or third-parties; failure to document transactions properly or to obtain proper authorization; failure to comply with applicable regulatory requirements; failures in the models we utilize and rely on; equipment failures, including those caused by electrical, telecommunications or other essential utility outages; business continuity and data security system failures, including those caused by computer viruses, cyberattacks, unforeseen problems encountered while implementing major new computer systems, upgrades to existing systems or inadequate access to data or poor response capabilities in light of such business continuity or data security system failures; or the inadequacy or failure of systems and controls, including those of our suppliers or counterparties. Our efforts to implement risk controls and loss mitigation actions, and the continuing trendresources we devote to developing efficient procedures, identifying and rectifying weaknesses in existing procedures and training staff, may not be adequate or effective in controlling all of consolidation in the financial services industry. Our profitability depends uponoperational risks faced by us. Failure of our continued ability to successfully compete with traditional and new financial services providers, some of which maintain a physical presence in our market areas and others of which maintain only a virtual presence. Increased competition could require us to increase the rates we pay on deposits risk controls and/or lower the rates that we offer on loans, which could reduce our profitability. Our failure to compete effectively in our market could restrain our growth or cause us to lose market share, whichloss mitigation actions could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to retain or grow our core deposit base, which could adversely impact our funding costs.
Like many financial institutions, we rely on customer deposits as our primary source of funding for our lending activities, and we continuethird party vendors to seek customer deposits to maintain this funding base. Our future growth will largely depend on our ability to retain and grow our deposit base. As of December 31, 2017, we had $4.0 billion in deposits and a loan to deposit ratio of 127.6%, which is higher than the level maintained by many other banks. As of the same date, using deposit account related information such as tax identification numbers, account vesting and account size, we estimated that $917.0 millionprovide key components of our deposits exceeded the insurance limits established by the Federal Deposit Insurance
Corporation, or FDIC. None of our deposits are governmental deposits secured by collateral. Although we have historically maintained a high deposit customer retention rate, these deposits are subjectbusiness infrastructure. We rely on numerous third parties to potentially dramatic fluctuations in availability or price due to certain factors outside of our control, such as increasing competitive pressures for deposits, changes in interest ratesprovide us with products and returns on other investment classes, customer perceptions of our financial health and general reputation, or a loss of confidence by customers in us or the banking sector generally, which could result in significant outflows of deposits within short periods of time or significant changes in pricingservices necessary to maintain current customer depositsour day-to-day operations including, but not limited to, our core processing function and mortgage broker relationships. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements. The failure of an external vendor to perform in accordance with the contracted arrangements or attract additional deposits. Additionally,service level agreements because of changes in the vendor’s organizational structure, financial condition, support for existing products and services or strategic focus or for any such loss of fundsother reason, could resultbe disruptive to our operations, which in lower loan originations, whichturn could have a material adverse effectnegative impact on our business, financial condition and results of operations.
Recent changes in tax laws We also could have an adverse effect on us, our industry, our customers, the value of collateral securing our loans and demand for our loans.
Recent changes in tax laws could have an impact on the banking industry, borrowers and the market for single family residential and multifamily residential real estate. Among the changes are: a $750,000 aggregate limit on the deductibility of mortgage interest on single family residential mortgages originated on or after December 15, 2017; limitations on deductibility of business interest expense; and, a $10,000 limit on the deductibility of property taxes and state and local income taxes. These changes may have an adverse effect on the market for and valuation of single family residential properties and multifamily residential properties, and on the demand for such loans in the future. If home ownership or multifamily residential property ownership become less attractive, demand for our loans would decrease. The value of the properties securing loans in our portfolio may be adversely impacted as a result ofaffected to the changing economics of home ownership and multifamily residential ownership, which could requireextent such an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations. Additionally, certain borrowers could become less able to service their debts if these changes become effective. These changes could adversely affect our business, financial condition and results of operations.
Our reputationagreement is critical to our business, and damage to it could have a material adverse effect on us.
A key differentiating factor for our business isnot renewed by the strong reputation we are building in our markets. Maintaining a positive reputation is critical to attracting and retaining customers and employees. Adverse perceptions of us could make it more difficult for us to execute on our strategy. Harm to our reputation can arise from many sources, including actual or perceived employee misconduct, errors or misconduct by our third party vendorsvendor or other counterparties, litigation oris renewed on terms less favorable to us. Additionally, the bank regulatory actions, our failureagencies expect financial institutions to meet our high customer service and quality standards and compliance failures. Negative publicity about us, whether or not accurate, may damage our reputation, which could have a material adverse effect on our business, financial condition and results of operations.
Our allowancebe responsible for loan losses may be inadequate to absorb probable incurred losses inherent in the loan portfolio, which could have a material adverse effect on our business, financial condition and results of operations.
Experience in the banking industry indicates that a portionall aspects of our loans will become delinquent, and that some may only be partially repaid or may never be repaid at all. We may experience losses for reasons beyond our control, such as the impact of general economic conditions on customers and their businesses. In determining the size of our allowance for loan losses, we rely on an analysis of our loan portfolio considering historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, economic conditions and other pertinent information. The determination of the appropriate level of the allowance for loan losses is inherently highly subjective and requires usvendors’ performance, including aspects which they delegate to make significant estimates of and assumptions regarding current credit risk and future trends, all of which may change materially. Although we endeavor to maintain our allowance for loan losses at a level adequate to absorb any probable incurred losses inherent in the loan portfolio, these estimates of loan losses are necessarily subjective and their accuracy depends on the outcome of future events. Inaccurate management assumptions, continuing deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan and lease losses. In addition, our regulators, as an integral part of their examination process, periodically review our loan portfolio and the adequacy of our allowance for loan and lease losses and may require adjustments based upon judgments that are different than those of management. Further, if actual charge-offs in future periods exceed the amounts allocated to the allowance for loan and lease losses, we may need to increase our provision for loan and lease losses to restore the adequacy of our allowance for such losses. If we are required
to materially increase our level of allowance for loan and lease losses for any reason, these increases could adversely affect our business, financial condition and results of operations.
We are dependent on our management team and key employees, and if we are not able to retain them, our business operations could be materially adversely affected.
Our success depends, in large part, on our management team and key employees. Our management team has significant industry experience, although a number of members of our senior management team have only been with us for a few years. In addition, our loan origination activities are conducted by a small number of individuals.
Our future success also depends on our continuing ability to attract, develop, motivate and retain key employees. Qualified individuals are in high demand, and we may incur significant costs to attract and retain them. Because the market for qualified individuals is highly competitive, we may not be able to attract and retain qualified officers or candidates. The loss of any of our management team or our key employees could materially adversely affect our ability to execute our business strategy, and we may not be able to find adequate replacements on a timely basis, or at all. We cannot ensure that we will be able to retain the services of any members of our management team or other key employees. Though we have employment agreements in place with certain members of our management team they may still elect to leave at any time. Failure to attract and retain a qualified management team and qualified key employees could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to maintain consistent growth, earnings or profitability.
There can be no assurance that we will be able to continue to grow and to remain profitable in future periods, or, if profitable, that our overall earnings will remain consistent with our prior results of operations, or increase in the future. Our growth in recent years has been driven primarily by a strong multifamily housing market in our geographic footprint. A downturn in economic conditions in our markets, particularly in the real estate market, heightened competition from other financial services providers, an inability to retain or grow our core deposit base, regulatory and legislative considerations, and failure to attract and retain high-performing talent, among other factors, could limit our ability to grow assets, or increase profitability, as rapidly as we have in the past. Sustainable growth requires that we manage our risks by following prudent loan underwriting standards, balancing loan and deposit growth without materially increasing interest rate risk or compressing our net interest margin, maintaining more than adequate capital at all times, hiring and retaining qualified employees and successfully implementing our strategic initiatives. We have also recently entered new markets, including Portland, Oregon. We may not have, or may not be able to develop, the knowledge or relationships necessary to be successful in these new markets. Our failure to sustain our historical rate of growth, adequately manage the factors that have contributed to our growth or successfully enter new markets could have a material adverse effect on our earnings and profitability and, therefore on our business, financial condition and results of operations.
We may not be able to manage our growth effectively, which could adversely affect our business.
We may face a variety of risks and difficulties in pursuing our organic growth strategy and maintaining our growth, including:
maintaining asset quality;
finding suitable markets for expansion;
attracting funding to support additional growth;
managing execution risks;
attracting and retaining qualified management personnel and bankers;
maintaining adequate capital;
managing a growing number of customer relationships;
scaling technology platforms;
exceeding $10.0 billion or more in assets, which will subject us to additional regulatory burdens and expenses; and
achieving expected additional performance and production from our bankers.
To manage our growth and maintain adequate information and reporting systems within our organization, we must identify, hire and retain qualified employees, particularly in the accounting and operational areas of our business. We must also successfully implement improvements to, or integrate, our management information and control systems, procedures and processes in an efficient and timely manner and identify deficiencies in existing systems and controls. In particular, our controls and procedures must be able to accommodate an increase in loan volume in various markets
and the infrastructure that comes with expanding operations, including new branches. Our growth strategy may divert management from our existing franchises and may require us to incur additional expenditures to expand our administrative and operational infrastructure. If we are unable to effectively manage and grow our banking franchise, we may experience compliance and operational problems, have to slow the pace of growth, or have to incur additional expenditures beyond current projections to support such growth, any one of which could materially and adversely affect our business, financial condition and results of operations.
Regulatory requirements affecting our loans secured by commercial real estate could limit our ability to leverage our capital and adversely affect our growth and profitability.
The federal banking agencies have issued guidance for institutions that are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution's total risk-based capital; or (ii) total commercial real estate loans representing 300% or more of the institution's total risk-based capital and the outstanding balance of the institution's commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. We have a concentration in commercial real estate loans, and multifamily residential real estate loans in particular, and we have experienced significant growth in our commercial real estate portfolio in recent years. As of December 31, 2017, commercial real estate loans represent 470% of the Company's total risk-based capital, of which multifamily residential real estate loans, the vast majority of which are 50% risk weighted for regulatory capital purposes, were 446% of the Company's total risk-based capital. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to its commercial real estate portfolio. Nevertheless, we could be required to maintain higher levels of capital as a result of our commercial real estate concentration, which could limit our growth, require us to obtain additional capital, and have a material adverse effect on our business, financial condition and results of operations.
Lack of seasoning of our loan portfolio could increase risk of credit defaults in the future.
third parties. As a result, of our organic growth over the past several years, as of December 31, 2017, approximately $4.3 billion, or 87.0%, of the loans in our loan portfolio were first originated since January 1, 2014. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as "seasoning." As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Although a significant portion of our multifamily portfolio are refinancings of prior loans on the same property, a large portion of our loan portfolio is relatively new, and therefore the current level of delinquencies and defaults may not represent the level that may prevail as the portfolio becomes more seasoned and may not serve as a reliable basis for predicting the health and nature of our loan portfolio, including net charge-offs and the ratio of nonperforming assets in the future. Our limited experience with these loans does not provide us with a significant history pattern with which to judge future collectability or performance. However, we believe that our stringent credit underwriting process, our ongoing credit review processes, and our history of successful management of our loan portfolio, mitigate these risks. Nevertheless, if delinquencies and defaults increase, we may be required to increase our provision for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and meet our obligations as they become due and failure to maintain sufficient liquidity could materially adversely affect our growth, business, profitability and financial condition.
Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding at a reasonable cost, in a timely manner and without adverse conditions or consequences. We require sufficient liquidity to fund asset growth, meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. Liquidity risk can increase due to a number of factors, including an over-reliance on a particular source of funding or market-wide phenomena such as market dislocation and major disasters. Factors that could detrimentally impact access to liquidity sources include, but are not limited to, a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated, adverse regulatory actions against us, or changes in the liquidity needs of our depositors.
Market conditions or other events could also negatively affect the level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Our inability to raise funds through deposits, borrowings, the sale of loans, and other sources could have a substantial negative effect on our business, and could result in the closure of the Bank. Our access to funding sources in amounts adequate to finance our activities or on acceptable terms could be impaired by factors that affect our organization specifically or the financial services industry or economy in general. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity could impair our ability to fund operations and meet our obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.
We rely on customer deposits, advances from the Federal Home Loan Bank of San Francisco, or FHLB, and brokered deposits to fund our operations. Although we have historically been able to replace maturing deposits and advances if desired, including throughout the recent recession, we may not be able to replace such funds in the future if our financial condition, the financial condition of the FHLB or market conditions change. FHLB borrowings and other current sources of liquidity may not be available or, if available, sufficient to provide adequate funding for operations.
Limits on our ability to use brokered deposits as part of our funding strategy may adversely affect our ability to grow.
A "brokered deposit" is any deposit that is obtained from or through the mediation or assistance of a deposit broker. These deposit brokers attract deposits from individuals and companies throughout the country and internationally whose deposit decisions are based almost exclusively on obtaining the highest interest rates. We have used brokered deposits in the past, and we intend to continue to use brokered deposits as one of our funding sources to support future growth. There are risks associated with using brokered deposits. In order to continue to maintain our level of brokered deposits, we may be forced to pay higher interest rates than those contemplated by our asset-liability pricing strategy. In addition, banks that become less than "well-capitalized" under applicable regulatory capital requirements may be restricted in their ability to accept or renew, or prohibited from accepting or renewing, brokered deposits. If this funding source becomes more difficult to access, we will have to seek alternative funding sources in order to continue to fund our growth. This may include increasing our reliance on FHLB borrowing, attempting to attract additional non-brokered deposits, and selling loans. There can be no assurance that brokered deposits will be available, or if available, sufficient to support our continued growth. The unavailability of a sufficient volume of brokered deposits could have a material adverse effect on our business, financial condition and results of operations.
New lines of business, products, product enhancements or services may subject us to additional risk.
From time to time, we may implement new lines of business or offer new products and product enhancements as well as new services within our existing lines of business. There are substantial risks and uncertainties associated with these efforts. In developing, implementing or marketing new lines of business, products, product enhancements or services, we may invest significant time and resources. We may underestimate the appropriate level of resources or expertise necessary to make new lines of business or products successful or to realize their expected benefits. We may not achieve the milestones set in initial timetables for the development and introduction of new lines of business, products, product enhancements or services, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the ultimate implementation of a new line of business or offerings of new products, product enhancements or services. Any new line of business, product, product enhancement or service could have a significant impact on the effectiveness of our system of internal controls. We may also decide to discontinue businesses or products, due to lack of customer acceptance or unprofitability. Failure to successfully manage these risks in the development and implementation of new lines of business or offerings of new products, product enhancements or services could have a material adverse effect on our business, financial condition and results of operations.
We depend on the accuracy and completeness of information provided by customers and counterparties.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished by or on behalf of customers and counterparties, including financial information. We may also rely on representations of customers and counterparties as to the accuracy and completeness of that information. In deciding whether to extend credit, we may rely upon customers' representations that their financial statements present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We also may rely on customer representations and certifications, or other audit or accountants' reports, with respect to the business and financial condition of our customers. Our financial condition, results of operations, financial reporting
and reputation could be negatively affected if we rely on materially misleading, false, inaccurate or fraudulent information.
We depend on information technology and telecommunications systems of third parties, and any systems failures or interruptions could adversely affect our operations and financial condition.
Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems. We outsource many of our major systems, such as data processing, deposit processing, loan origination, email and anti-money laundering monitoring systems. Of particular significance is our long term contract for core data processing services with Fiserv. The failure of these systems, or the termination of a third party software license or service agreement on which any of these systems is based, could interrupt our operations, and we could experience difficulty in implementing replacement solutions. In many cases our operations rely heavily on secured processing, storage and transmission of information and the monitoring of a large number of transactions on a minute-by-minute basis, and even a short interruption in service could have significant consequences. Because our information technology and telecommunications systems interface with and depend on third party systems, we could experience service denials if demand for such services exceeds capacity or such third party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, failure of third parties to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of these third parties could disrupt our operations or adversely affect our reputation.
We are subject to cybersecurity risks and security breaches and may incur increasing costs in an effort to minimize those risks and to respond to cyber incidents, and we may experience harm to our reputation and liability exposure from security breaches.
Our business involves the storagemay be adversely affected by an increasing prevalence of fraud and transmission of consumers' proprietary information, and security breaches could expose us to a risk of loss or misuse of this information, litigation and potential liability. While we have incurred no material cyber-attacks or security breaches to date, a number of other financial services and other companies have disclosed cyber-attacks and security breaches, some of which have involved intentional attacks. Attackscrime. Our Bank is susceptible to fraudulent activity that may be targeted atcommitted against us or our customers which may result in financial losses or both. Although we devote significant resources to maintain, regularly update and backup our systems and processes that are designed to protect the security of our computer systems, software, networks and other technology assets and the confidentiality, integrity and availability of information belongingincreased costs to us or our customers, our security measures may not be effective against all potential cyber-attacksdisclosure or security breaches. Despite our efforts to ensure the integritymisuse of our systems, it is possible that we may not be able to anticipatecustomers' or to implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently or are not recognized until launched, and because cyber-attacks can originate from a wide variety of sources, including persons who are involved with organized crime or associated with external service providers or who may be linked to terrorist organizations or hostile foreign governments. These risks may increase in the future as we continue to increase our internet-based product offerings and expand our internal usage of web-based products and applications. If an actual or perceived security breach occurs, customer perception of the effectiveness of our security measures could be harmed and could result in the loss of customers.
A successful penetration or circumvention of the security of our systems, including those of third party providers or other financial institutions, or the failure to meet regulatory requirements for security of our systems, could cause serious negative consequences, including significant disruption of our operations,information, misappropriation of our confidential information or that ofassets, privacy breaches against our customers, litigation or damage to our computers or systems or those of our customers or counterparties, significant increases in compliance costs (such as repairing systems or adding new personnel or protection technologies), and could result in violations of applicable privacyreputation. Such fraudulent activity may take many forms, including wire fraud, check fraud, electronic fraud, phishing, social engineering and other laws,dishonest acts. The reported incidents of fraud and other financial loss to us or to our customers, loss of confidencecrimes have increased overall and we may experience material losses in our security measures, customer dissatisfaction, significant litigation and regulatory exposure, and harm to our reputation, all of whichthe future that could have a material adverse effect on our reputation, business, financial condition and results of operations.
Risks Related to Information Technology, Cybersecurity and Data Privacy
If the technology we use in operating our business fails, is unavailable, or does not operate to expectations, our business and results of operations could be adversely affected. Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems. Our policies and procedures to prevent or limit the impact of systems failures and interruptions may prove inadequate to prevent such events or to adequately address those events that we do experience. Even if we have well designed policies and procedures, we will remain vulnerable to such events. In addition, we outsource many aspects of our data processing and other operational functions to certain third-party providers, of particular significance is our long-term contract for core data processing with Fiserv. The contracts and relationships we have with our vendors may not place adequate controls around their actions, or they may breach those contracts. If our vendors encounter difficulties, including those resulting from disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches, or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. The failure of the systems on which we rely, or the termination or breach of a third party software license or service agreement on which any of these systems is based, could interrupt our operations, and we could experience difficulty in implementing replacement solutions.
The occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse impact on our financial condition and results of operations.
Failure to keep uppace with the rapid technological changes in the financial services industry could have a material adverse effect on our competitive position and profitability.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial
institutions to better serve customers and reduce costs. Our future success will depend, in part, upon our ability and willingness to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we have. We may not be able to implement new technology-driven products and services effectively or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could harm our ability to compete effectively and could have a material adverse effect on our business, financial condition or results of operations. As these technologies are improved in the future, we may be required to make significant capital expenditures in order to remain competitive, which may increase our overall expenses and have a material adverse effect on our business, financial condition and results of operations.
Any significant disruption in or unauthorized access to our computer systems or those of third parties that we utilize in our operations, including those relating to cybersecurity or arising from cyber-attacks, could result in a loss or degradation of service or unauthorized disclosure of data, including customer and Company information, which could adversely affect our business. Our business involves the storage and transmission of customers' proprietary information, and security breaches could expose us to a risk of loss or misuse of this information, litigation and potential liability. Our computer systems and those of third parties we use in our operations are subject to cybersecurity threats, including, but not limited to: destructive malware, ransomware, attempts to gain unauthorized access to systems or data, unauthorized release of confidential information, corruption of data, networks or systems, zero-day attacks and malicious software. The measures in place to address and mitigate cyber-related risks may be inadequate and our investments in the cybersecurity and resiliency of our networks and to enhance our internal controls and processes may not be adequate to protect the security of our computer systems, software, networks and other technology assets and the confidentiality, integrity and availability of information belonging to us or our customers. Cybersecurity risk management programs are expensive to maintain, and even well-designed and well-funded systems may not be effective against all potential cyber-attacks or security breaches. Moreover, as technology and cyberattacks change over time, we must continually monitor and change systems to guard against new threats. We may not know of or be able to guard against a new threat until after an attack has occurred.
A successful penetration or circumvention of the security of our systems, including those of third-party providers or other financial institutions, or the failure to meet regulatory requirements for security of our systems, could cause serious negative consequences, including significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage to our computers or systems or those of our customers or counterparties, significant increases in compliance costs (such as repairing systems or adding new personnel or protection technologies), and could result in violations of applicable privacy and other laws, financial loss to us or to
our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation and regulatory exposure, and severe harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
We are subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws could damage our reputation or otherwise adversely affect our business. Our business requires the collection and retention of volumes of customer data, including personally identifiable information (“PII”) in various information systems that we maintain and in those maintained by third party service providers. We also maintain important internal company data such as PII about our employees and information relating to our operations. We are subject to complex and evolving laws and regulations regarding the privacy and protection of PII of individuals (including customers, employees, and other third parties) including the Gramm-Leach-Bliley Act and the California Consumer Privacy Act. Various federal and state banking regulators and states have also enacted data breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in the event of a security breach. Ensuring that our collection, use, transfer and storage of PII complies with all applicable laws and regulations has increased, and is likely to continue increasing, our costs. Furthermore, we may not be able to ensure that customers and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information or where such information was intercepted or otherwise compromised by third parties), we could be exposed to litigation or regulatory sanctions under privacy and data protection laws and regulations. Concerns regarding the effectiveness of our measures to safeguard PII, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers and thereby reduce our revenue. Accordingly, any failure, or perceived failure, to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or result in significant liabilities, fines or penalties, and could damage our reputation and otherwise adversely affect our operations, financial condition and results of operations.
Risks Related to Risk Management
Our risk management framework may not be effective in mitigating risks and/or losses to us.
Our risk management framework is comprised of various processes, systems and strategies and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, operational, interest rate and compliance. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances. Our risk management frameworkand may not adequately mitigate any risk or loss to us. If our risk management framework is not effective, we could suffer unexpected losses and our business, financial condition, results of operations or growth prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
We are no longer an “emerging growth company,” and as such, the cost of compliance with Section 404 of the Sarbanes-Oxley Act of 2002 may be adversely affectedaffect our results of operations. Under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), management is required to annually assess and report on the effectiveness of our internal control over financial reporting and include an attestation report by the soundnessCompany’s independent auditors addressing the effectiveness of otherour internal control over financial institutions.
Our abilityreporting. As an emerging growth company, we availed ourselves of the exemption from the requirement that our independent registered public accounting firm attest to engage in routine funding transactions couldthe effectiveness of our internal control over financial reporting under Section 404. However, we may no longer avail ourselves of this exemption since we ceased to be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, and other relationships.an “emerging growth company” on December 31, 2022. As a result, defaults by, or even rumors or questions about, one or moreour independent registered public accounting firm is required to undertake an assessment of our internal control over financial services companies, orreporting and the financial services industry generally,cost of our compliance with Section 404 will correspondingly increase and require significant management time, which could lead to market-wide liquidity problems and losses or defaults by us or other institutions. These losses could have a material adverse effect onadversely affect our business, financial condition and results of operations.
We are dependent on the use of data and modeling in both our management's decision making generally, and in meeting regulatory expectations in particular.
The use of statistical and quantitative models and other quantitatively-based analyses is endemic to bank decision making and regulatory compliance processes, and the employment of such analyses is becoming increasingly widespread in our operations. Liquidity stress testing, interest rate sensitivity analysis, allowance for loan loss measurement, loan portfolio stress testing and the identification of possible violations of anti-money laundering regulationssuspicious activity are examples of areas in which we are dependent on models and the data that underlies them. We anticipate that model-derived insights will be used more widely in our decision making in the future. While theseThese quantitative techniques and approaches improve our decision making, they also create the possibility that faulty data or flawed quantitative approaches could yield regulatory scrutiny or adverse outcomes, or regulatory scrutiny.including increased exposure due to errors. Secondarily, because of the complexity inherent in these approaches, misunderstanding or misuse of their
outputs could similarly result in suboptimal decision making, which could have a material adverse effect on our business, financial condition and results of operations.
Legal and Regulatory Risk
If we fail to design, implementOur industry is highly regulated, and maintain effective internal control over financial reporting or remediatethe regulatory framework, together with any future material weakness inlegislative or regulatory changes, may have a materially adverse effect on our internal control over financial reporting,operations. The banking industry is highly regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, the public, the banking system as a whole or the FDIC Deposit Insurance Fund, not for the protection of our shareholders and creditors. Compliance with these laws and regulations can be difficult and costly, and changes to them can impose additional compliance costs. Applicable laws and regulations govern a variety of matters, including permissible types; amounts and terms of loans and investments we may make; the maximum interest rate that may be unablecharged; the types of deposits we may accept and the rates we may pay on such deposits; maintenance of adequate capital and liquidity; changes in control of the Bank and/or Luther Burbank Corporation, as the Bank's holding company; inter-company transactions; handling of nonpublic information; restrictions on dividends and establishment of new offices. We must obtain approval from our regulators before engaging in certain activities, and there is risk that such approvals may not be granted, in a timely manner or at all. These requirements may constrain our operations, and the adoption of new laws and changes to accurately reportor repeal of existing laws may have a further impact on our business, financial condition and results of operations. Also, the burden imposed by those federal and state regulations may place banks in general, including our Bank in particular, at a competitive disadvantage compared to non-bank competitors. Our failure to comply with any applicable laws or prevent fraud,regulations, or regulatory policies and interpretations of such laws and regulations, could result in sanctions by regulatory agencies or damage to our reputation, all of which could have a material adverse effect on us.our business, financial condition and results of operations.
Our internal control overBank holding companies and financial reporting is designed to provide reasonable assurance regarding the reliability of the financial reportinginstitutions are extensively regulated and the preparation of financial statements for external purposes in accordance with GAAP. Effective internal control over financial reporting is necessary for us to provide reliable reportscurrently face an uncertain regulatory environment. Applicable laws, regulations, interpretations, enforcement policies and prevent fraud.
We are in the process of documenting, reviewing and, if appropriate, enhancing our internal controls and procedures in anticipation of beingaccounting principles have been subject to significant changes in recent years, and may be subject to significant future changes. Future changes may have a material adverse effect on our business, financial condition and results of operations.
Regulatory agencies may adopt changes to their regulations or change the requirementsmanner in which existing regulations are applied. We cannot predict the substance or effect of Section 404pending or future legislation or regulation or the application of laws and regulations to us. Compliance with current and potential regulation, as well as regulatory scrutiny, may significantly increase our costs, impede the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), which will require annual management assessments of the effectivenessefficiency of our internal control over financial reportingbusiness processes, require us to increase our regulatory capital, and when we ceaselimit our ability to bepursue business opportunities in an emerging growth company under the JOBS Act, a reportefficient manner by the Company’s independent auditors addressing our internal control over financial reporting. Our managementrequiring us to expend significant time, effort and resources to ensure compliance and respond to any regulatory inquiries or investigations.
In addition, regulators may conclude that our internal control over financial reporting is not effective dueelect to the failure to cure any identified material
weakness or otherwise. Moreover, even if management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may not conclude that our internal control over financial reporting is effective. In the course of their review, our independent registered public accounting firm may not be satisfied with the internal control over financial reportingalter standards or the level at which the controls are documented, designed, operated or reviewed, or it may interpret the relevant requirements differently from the Company. In addition, during the courseinterpretation of the evaluation, documentation and testing of our internal control over financial reporting, we may identify deficiencies that we may not be ablestandards used to remediate in timemeasure regulatory compliance or to meet the deadline imposed by the SEC for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act. Any such deficiencies may also subject us to adverse regulatory consequences. If we fail to achieve and maintaindetermine the adequacy of internal control overliquidity, risk management or other operational practices for financial reporting, as these standards are modified, supplementedinstitutions in a manner that impacts our ability to implement our strategy and could affect us in substantial and unpredictable ways, and could have a material adverse effect on our business, financial condition and results of operations. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of laws and regulations and their assessment of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency's assessment of the quality of our assets, operations, lending practices, investment practices, funding sources, capital structure or amendedother aspects of our business differs from time to time,our assessment, we may be unablerequired to report our financial information on a timely basis, may not be able to conclude on an ongoing basistake additional charges or undertake, or refrain from taking, actions that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act, and may suffer adverse regulatory consequences or violate Nasdaq's listing standards. There could also be a negative reaction in the financial markets due to a loss of investor confidence in the reliability of our financial statements.
We believe that a control system, no matter how well designed and managed, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. We may not be able to identify all significant deficiencies and/or material weaknesses in our internal control in the future, and our failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business, financial condition and results of operations.
We may need to raise additional capital in the future, and we may not be able to do so.
Access to sufficient capital is critical in order to enable us to implementRegulatory requirements affecting our business plan, support our business, expand our operations, and meet applicable capital requirements. The inability to have sufficient capital, whether internally generated through earnings or raised in the capital markets,loans secured by commercial real estate could adversely impactlimit our ability to support and to growleverage our operations. If we grow our operations faster than we generate capital internally, we will need to access the capital markets. We may not be able to raise additional capital in the form of additional debt or equity. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, our financial condition and our results of operations. Economic conditions and a loss of confidence in financial institutions may increase our cost of capital and limit access to some sources of capital. Such capital may not be available on acceptable terms, or at all. Any occurrence that may limit our access to the capital markets, or disruption in capital markets, may adversely affect our capital costsgrowth and our abilityprofitability. The federal banking agencies have issued guidance for institutions that are deemed to raise capital. Further, if we needhave concentrations in CRE lending. Institutions which are deemed to raise capitalhave concentrations in CRE lending pursuant to the supervisory criteria in the future,relevant guidance are expected to employ heightened levels of risk management with respect to their CRE portfolios, and may be required to hold higher levels of capital. We have a concentration in CRE loans, and multifamily residential real estate loans in particular, and we may have experienced significant growth in our CRE portfolio in recent years. As of December 31, 2022, CRE loans represent 584% of the Company's total risk-based capital. Multifamily residential real estate loans, the vast majority of which are 50% risk weighted for regulatory capital purposes, were 560% of the Company's total risk-based capital. Management has extensive experience in CRE lending, and has implemented and continues to do so when many other financial institutions are also seekingmaintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to raiseits CRE portfolio. Nevertheless, we could be required to maintain higher levels of capital and would then haveas a result of our CRE
concentration, which could limit our growth, require us to compete with those institutions for investors. An inability to raiseobtain additional capital, on acceptable terms when needed couldand have a material adverse impacteffect on our business, financial condition and results of operations.
Litigation and regulatory actions, including possible enforcement actions, could subject us to significant fines, penalties, judgments or other requirements resulting in increased expenses or restrictions on our business activities.
In the normal course of business, from time to time, we have in the past and may in the future be named as a defendant in various legal actions, arising in connection with our current and/or prior business activities. Legal actions could include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. Further we may in the future be subject to consent orders with our regulators. We may also, from time to time, be the subject of subpoenas, requests for information, reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding our current and/or prior business activities. Any such legal or regulatory actions may subject us to substantial compensatory or punitive damages, significant fines, penalties, obligations to change our business practices or other requirements resulting in increased expenses, diminished income and damage to our reputation. Our involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined in our favor, could also cause significant harm to our reputation and divert management attention from the operation of our business. Further, any settlement, consent order or adverse judgment in connection with any formal or informal proceeding or investigation by government agencies may result in litigation, investigations or proceedings as other litigants and government agencies begin independent reviews of the same activities. As a result, the outcome of legal and regulatory actions could have a material adverse effect on our business, results of operations and results of operations.
We are subject to an extensive body of accounting rules and best practices. Periodic changes to such rules may change the treatment and recognition of critical financial line items and affect our profitability.
The nature of our business makes us sensitive to the large body of accounting rules in the U.S. From time to time, the governing bodies that oversee changes to accounting rules and reporting requirements may release new guidance for the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some instances, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. Changes which have been approved for future implementation, or which are currently proposed or expected to be proposed or adopted include requirements that we: (i) calculate the allowance for loan losses on the basis of the current expected loan losses over the lifetime of our loans (the "CECL model"), which is expected to be applicable to us beginning in 2021; and (ii) record the value of and liabilities relating to operating leases on our balance sheet, which is expected to be applicable beginning in 2020. These changes could adversely affect our capital, regulatory capital ratios, ability to make larger loans, earnings and performance metrics. Any such changes could have a material adverse effect on our business, financial condition and results of operations.
Under the CECL model, banks will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determines our allowance for loan losses, and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of the allowance for loan losses. If we are required to materially increase the level of the allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations. We are evaluating the impact the CECL accounting model will have on our accounting, but expect to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations.
The fair value of our investment securities can fluctuate due to factors outside of our control.
Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, and changes in market interest rates and instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments, or OTTI, and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could materially and adversely affect our business, financial condition or results of operations. The process for determining whether impairment of a security is OTTI usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer, any collateral underlying the security and our intent and ability to hold the security for a sufficient period of time to allow for any anticipated recovery in fair value, in order to assess the probability of receiving all contractual principal and interest payments on the security. Our failure to correctly and timely assess any impairments or losses with respect to our securities could have a material adverse effect on our business, financial condition or results of operations.
Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR may adversely affect our results of operations.
Regulators and law enforcement agencies in a number of countries are conducting civil and criminal investigations into whether the banks that contribute to the British Bankers' Association (the "BBA") in connection with the calculation of LIBOR may have been under-reporting or otherwise manipulating or attempting to manipulate LIBOR. A number of BBA member banks have entered into settlements with their regulators and law enforcement agencies with respect to this alleged manipulation of LIBOR. Actions by the BBA, regulators or law enforcement agencies may result in changes to the manner in which LIBOR is determined or the establishment of alternative reference rates. At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR that may be enacted. Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may adversely affect the value of LIBOR-based loans and securities in our portfolio,
and may impact the availability and cost of hedging instruments and borrowings. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may incur significant expenses in effecting the transition, and may be subject to disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.
We may pursue strategic acquisitions in the future, and we may not be able to overcome risks associated with such transactions.
Although we plan to continue to grow our business organically, we may explore opportunities to invest in, or to acquire, other financial institutions and businesses that we believe would complement our existing business. Our investment or acquisition activities could be material to our business and involve a number of risks including the following:
investing time and incurring expense associated with identifying and evaluating potential investments or acquisitions and negotiating potential transactions, resulting in our attention being diverted from the operation of our existing business;
the lack of history among our management team in working together on acquisitions and related integration activities;
the time, expense and difficulty of integrating the operations and personnel of the combined businesses;
unexpected asset quality problems with acquired companies;
inaccurate estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution or assets;
risks of impairment to goodwill or other-than-temporary impairment of investment securities;
potential exposure to unknown or contingent liabilities of banks and businesses we acquire;
an inability to realize expected synergies or returns on investment;
potential disruption of our ongoing banking business; and
loss of key employees or key customers following our investment or acquisition.
We may not be successful in overcoming these risks or other problems encountered in connection with potential investments or acquisitions. Our inability to overcome these risks could have an adverse effect on our ability to implement our business strategy and enhance shareholder value, which, in turn, could have a material adverse effect on our business, financial condition or results of operations. Additionally, if we record goodwill in connection with any acquisition, our financial condition and results of operation may be adversely affected if that goodwill is determined to be impaired, which would require us to take an impairment charge.
Risks Related to Our Industry
Our industry is highly regulated, and the regulatory framework, together with any future legislative or regulatory changes, may have a materially adverse effect on our operations.
The banking industry is highly regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, the public, the banking system as a whole or the FDIC Deposit Insurance Fund, not for the protection of our shareholders and creditors. We are subject to regulation and supervision by the Federal Reserve, and our Bank is subject to regulation and supervision by the FDIC and the California Department of Business Oversight Division of Financial Institutions, or DBO. Compliance with these laws and regulations can be difficult and costly, and changes to laws and regulations can impose additional compliance costs. The Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, which imposes significant regulatory and compliance changes on financial institutions, is an example of this type of federal regulation. The laws and regulations applicable to us govern a variety of matters, including permissible types, amounts and terms of loans and investments we may make, the maximum interest rate that may be charged, the amount of reserves we must hold against deposits we take, the types of deposits we may accept and the rates we may pay on such deposits, maintenance of adequate capital and liquidity, changes in control of us and our Bank, transactions between us and our Bank, handling of nonpublic information, restrictions on dividends and establishment of new offices. We must obtain approval from our regulators before engaging in certain activities, and there is risk that such approvals may not be granted, either in a timely manner or at all. These requirements may constrain our operations, and the adoption of new laws and changes to or repeal of existing laws may have a further impact on our business, financial condition and results of operations. Also, the burden imposed by those federal and state regulations may place banks in general, including our Bank in particular, at a competitive disadvantage compared to their non-bank competitors. Our failure to comply with any applicable laws or regulations, or regulatory policies and interpretations of such laws and regulations, could result in sanctions by regulatory agencies, civil money penalties or damage to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
Bank holding companies and financial institutions are extensively regulated and currently face an uncertain regulatory environment. Applicable laws, regulations, interpretations, enforcement policies and accounting principles have been subject to significant changes in recent years, and may be subject to significant future changes. Future changes may have a material adverse effect on our business, financial condition and results of operations.
Federal and state regulatory agencies may adopt changes to their regulations or change the manner in which existing regulations are applied. We cannot predict the substance or effect of pending or future legislation or regulation or the application of laws and regulations to us. Compliance with current and potential regulation, as well as regulatory scrutiny, may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital, and limit our ability to pursue business opportunities in an efficient manner by requiring us to expend significant time, effort and resources to ensure compliance and respond to any regulatory inquiries or investigations.
In addition, given the current economic and financial environment, regulators may elect to alter standards or the interpretation of the standards used to measure regulatory compliance or to determine the adequacy of liquidity, risk management or other operational practices for financial service companies in a manner that impacts our ability to implement our strategy and could affect us in substantial and unpredictable ways, and could have a material adverse effect on our business, financial condition and results of operations. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of laws and regulations and their assessment of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency's assessment of the quality of our assets, operations, lending practices, investment practices, capital structure or other aspects of our business differs from our assessment, we may be required to take additional charges or undertake, or refrain from taking, actions that could have a material adverse effect on our business, financial condition and results of operations.
Federal and state regulators periodically examine our business and may require us to remediate adverse examination findings or may take enforcement action against us.
The Federal Reserve, the FDIC and the DBO periodically examine our business, including our compliance with laws and regulations. If, as a result of an examination, the Federal Reserve, the FDIC, or the DBO were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, they may take
a number of different remedial actions as they deem appropriate. These actions include the power to require us to remediate any such adverse examination findings.
In addition, these agencies have the power to take enforcement action against us to enjoin "unsafe or unsound" practices, to require affirmative action to correct any conditions resulting from any violation of law or regulation or unsafe or unsound practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to direct the sale of subsidiaries or other assets, to limit dividends and distributions, to restrict our growth, to assess civil money penalties against us or our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is imminent risk of loss to depositors, to terminate our deposit insurance and place our Bank into receivership or conservatorship. Any regulatory enforcement action against us could have a material adverse effect on our business, financial condition and results of operations.
We may be required to act as a source of financial and managerial strength for our Bank in times of stress.
Under federal law and long-standing Federal Reserve policy, we, as a bank holding company, are required to act as a source of financial and managerial strength to our Bank and to commit resources to support our Bank if necessary. We may be required to commit additional resources to our Bank at times when we may not be in a financial position to provide such resources or when it may not be in our, or our shareholders' or creditors', best interests to do so. A requirement to provide such support is more likely during times of financial stress for us and our Bank, which may make any capital we are required to raise to provide such support more expensive than it might otherwise be. In addition, any capital loans we make to our Bank are subordinate in right of repayment to deposit liabilities of our Bank.
Regulatory initiatives regarding bank capital requirements may require heightened capital.
Regulatory capital rules adopted in July 2013, implement higher minimum capital requirements for bank holding companies and banks. These rules, which implement the Basel III regulatory capital reforms, from the Basel Committee on Banking Supervision, include a common equity Tier 1 capital requirement and establish criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. These enhancements were intended to both improve the quality and increase the quantity of capital required to be held by banking organizations, and to better equip the U.S. banking system to deal with adverse economic conditions. The capital rules require bank holding companies and banks to maintain a common equity Tier 1 capital ratio of 4.5%, a minimum total Tier 1 risk based capital ratio of 6%, a minimum total risk based capital ratio of 8%, and a minimum leverage ratio of 4%. Bank holding companies and banks are also required to hold a capital conservation buffer of common equity Tier 1 capital of 2.5% (when fully phased in) to avoid limitations on capital distributions and discretionary executive compensation payments. The revised capital rules will also require banks to maintain a common equity Tier 1 capital ratio of 6.5% or greater, a Tier 1 capital ratio of 8% or greater, a total capital ratio of 10% or greater and a leverage ratio of 5% or greater to be deemed "well-capitalized" for purposes of certain rules and prompt corrective action requirements.
The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing significant internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Our regulatory capital ratios currently are in excess of the levels established for "well-capitalized" institutions. Future regulatory change could impose higher capital standards.
Any new or revised standards adopted in the future may require us to maintain materially more capital, with common equity as a more predominant component, or manage the configuration of our assets and liabilities to comply with formulaic liquidity requirements. We may not be able to raise additional capital at all, or on terms acceptable to us. Failure to maintain capital to meet current or future regulatory requirements could have a significant material adverse effect on our business, financial condition and results of operations.
We face a risk of noncompliance and enforcement action withare subject to the Bank Secrecy Act and other anti-money laundering statutes and regulations.
regulations, and failure to comply with these laws could lead to a wide variety of sanctions, damage our reputation and otherwise adversely affect our business.The Bank Secrecy Act of 1970, the Uniting and Strengthening America by Providing Appropriate Tools to Intercept and Obstruct Terrorism Act of 2001 or the USA ("Patriot Act or Patriot Act,Act"), and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and to file reports such as suspicious activity reports and currency transaction reports. We are required to comply with these and other anti-money laundering requirements. Our federal and state banking regulators, the Financial Crimes Enforcement
Network, or FinCEN, and other government agencies are authorized to impose significant civil money penalties for violations of anti-money laundering requirements. We are also subject to increased scrutiny of compliance with the regulations issued and enforced by the Office of Foreign Assets Control or OFAC.("OFAC"). If our program is deemed deficient, we could be subject to liability, including fines, civil money penalties and other regulatory actions, which may include restrictions on our business operations and our ability to pay dividends, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have significant reputational consequences for us. Any of these circumstances could have a material adverse effect on our business, financial condition or results of operations.
We are subject to numerous "fair and responsible banking"consumer protection laws, designed to protect consumers, and failure to comply with these laws could lead to a wide variety of sanctions.
sanctions, damage our reputation and otherwise adversely affect our business.The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations, including state laws and regulations, prohibit discriminatory lending practices by financial institutions. The Federal Trade Commission Act and the Dodd-Frank Act prohibit unfair, deceptive, or abusive acts
or practices by financial institutions. The U.S. DepartmentWe are also subject to complex and evolving laws and regulations governing the privacy and protection of Justice, or DOJ, federal banking agencies,personally identifiable information of individuals (including customers, employees, and other federalthird parties), including, but not limited to, the Gramm-Leach-Bliley Act, and state agencies are responsible for enforcing these fair and responsible banking laws and regulations.the California Consumer Protection Act. A challenge to an institution's compliance with fairthese and responsible bankingother consumer protections laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution's performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our reputation, business, financial condition and results of operations.
Other Business Risks
We face significant and increasing competition in the financial services industry. The banking markets in which we operate are subject to laws regarding the privacy, information securityhighly competitive and protection of personal informationour future growth and any violation of these laws or another incident involving personal, confidential, or proprietary information of individuals could damage our reputation and otherwise adversely affect our business.
Our business requires the collection and retention of large volumes of customer data, including personally identifiable information, or PII, in various information systems that we maintain and in those maintained by third party service providers. We also maintain important internal company data such as PII about our employees and information relating to our operations. We are subject to complex and evolving laws and regulations governing the privacy and protection of PII of individuals (including customers, employees, and other third parties). For example, our business is subject to the Gramm-Leach-Bliley Act, or the GLB Act, which, among other things: (i) imposes certain limitationssuccess will depend on our ability to share nonpublic PII aboutcompete effectively in these markets. We compete for deposits, loans, and other financial services in our customersmarkets with nonaffiliated third parties; (ii) requestscommercial and community banks, credit unions, financial technology companies, mortgage banking firms and online mortgage lenders, including large national financial institutions that operate in our market area, and with the United States Department of the Treasury. Many of these competitors are larger than us, have significantly more resources and greater brand recognition than we provide certain disclosures to customers about our information collection, sharingdo, and security practices and afford customers the right to "opt out" of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (iii) requires that we develop, implement and maintain a written comprehensive information security program containing appropriate safeguards based on our size and complexity, the nature and scope of our activities, and the sensitivity of customer information we process, as well as plans for responding to data security breaches. Various federal and state banking regulators and states have also enacted data breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in the event of a security breach. Ensuring that our collection, use, transfer and storage of PII complies with all applicable laws and regulations can increase our costs. Furthermore, we may not be able to ensureattract customers more effectively than we can. Increased competition could require us to lower the rates that customerswe offer on loans and other third parties have appropriate controlscould require, and recently has required, us to increase the rates we pay on deposits, which could and recently has reduced our profitability. Our failure to compete effectively in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidentialour market could restrain our growth or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information, or where such information was intercepted or otherwise compromised by third parties), we could be exposed to litigation or regulatory sanctions under privacy and data protection laws and regulations. Concerns regarding the effectiveness of our measures to safeguard PII, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers and thereby reduce our revenues. Accordingly, any failure, or perceived failure to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties, and could damage our reputation and otherwise adversely affect our operations, financial condition and results of operations.
Our use of third party vendors and our other ongoing third party business relationships are subject to increasing regulatory requirements and attention.
We regularly use third party vendors in our business and we rely on some of these vendors for critical functions including, but not limited to, our core processing function and mortgage broker relationships. Third party relationships are subject to increasingly demanding regulatory requirements and attention by bank regulators. We expect our regulators to hold us responsible for deficiencies in our oversight or control of our third party vendor relationships and in the performance of the parties with which we have these relationships. As a result, if our regulators conclude that we have not exercised adequate oversight and control over our third party vendors or that such vendors have not performed adequately, we could be subject to administrative penalties or fines as well as requirements for consumer remediation, any ofmarket share, which could have a material adverse effect on our business, financial condition and results of operations. Additionally,
Our reputation is critical to our use of loan brokersbusiness, and damage to originate a portion of our multifamily residential loans and all of our single family residential loans, exposes us to risk of loss or liability in the event that such brokers misrepresent the borrower's financial condition or other information included in the loan package, or if the broker engages in violations of law in connection with the loan.
Rulemaking changes implemented by the Consumer Financial Protection Bureau will result in higher regulatory and compliance costs that may adversely affect our business.
The Dodd-Frank Act created a new, independent federal agency, the Consumer Financial Protection Bureau, or CFPB, which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws. The CFPB also has examination and primary enforcement authority with respect to depository institutions with assets over $10.0 billion, their third party service providers and non-depository entities such as debt collectors and consumer reporting agencies. The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more intense and complex environment for consumer finance regulation. The ultimate impact of this heightened scrutiny is uncertain but could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination. These changesit could have a material adverse effect on us. Our ability to attract and retain customers is highly dependent upon the perceptions of consumers and commercial borrowers and depositors and other external perceptions of our products, services, trustworthiness, business practices, workplace culture, compliance practice or our financial health. Negative public opinion or damage to our brand could result from actual or alleged conduct in any number of circumstances, including lending practices, regulatory compliance, security breaches, corporate governance, sales and marketing, and employee misconduct, as well as from our financial condition and resultsperformance. The policies and procedures we have in place to protect our reputation and promote ethical conduct may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of operations, even if we remain under the threshold of over $10.0 billion for CFPB supervision.
customers, investors and employees, litigation, a decline in revenue and increased regulatory scrutiny.
Risks Related to an Investment in Our Common Stock
Our stock price may be volatile, and you could lose part or all of your investment as a result.
Stock price volatility may negatively impact the price at which our common stock may be sold, and may also negatively impact the timing of any sale. Our stock price may fluctuate widely in response to a variety of factors including the risk factors described herein and, among other things:
actual or anticipated variations in quarterly operating results, financial conditions or credit quality;
changes in business or economic conditions;
recommendations or research reports about us or the financial services industry in general published by securities analysts;
the failure of securities analysts to continue cover us;
changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to us or other financial institutions;
reports in the press or investment community generally or relating to our reputation or the financial services industry, whether or not those reports are based on accurate, complete or transparent data;
news reports relating to trends, concerns and other issues in the financial services industry;
reports related to the impact of natural or man-made disasters in our markets;
perceptions in the marketplace regarding us and or our competitors;
significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors;
additional investments from third parties;
additions or departures of key personnel;
future sales or issuance of additional shares of stock;
actions of one or more investors in selling our common stock short;
fluctuations in the stock price and operating results of our competitors;
changes or proposed changes in laws or regulations, or differing interpretations thereof affecting our business, or enforcement of these laws or regulations;
new technology used, or services offered, by competitors;
additional investments from third parties; or
geopolitical conditions such as acts or threats of terrorism, pandemics or military conflicts.
The market price of our stock could be negatively affected by sales of substantial amounts of our common stock in the public markets.
Sales of a substantial number of shares of our common stock in the public market, or the perception that large sales could occur, could cause the market price of our common stock to decline or limit our future ability to raise capital through an offering of equity securities.
As of December 31, 2017, there were 56,422,662 shares of our common stock were issued and outstanding, including 409,835 shares of restricted stock and restricted stock units that had yet to vest. Of our issued and outstanding shares of common stock, all of these shares will be freely transferable, except for any shares held by our "affiliates," as that term is defined in Rule 144 under the Securities Act, in respect of which the applicable holding period has not yet passed. Trusts established for the benefit of the Chairman of our board of directors, Victor S. Trione, our former director and Secretary, Mark Trione and his wife, and each of the adult children of Messrs. Trione, collectively referred to as the Trione Family Trusts, currently control 70.9% of our common stock. This stock can be resold into the public markets in the future in accordance with the requirements of Rule 144. We, our executive officers and directors, and the Trione Family Trusts agreed with the underwriters that, subject to exceptions, we and they will not directly or indirectly sell or otherwise transfer their shares for a period of 180 days after the date of the Prospectus for our initial public offering. The market price for our common stock may decline significantly when the restrictions on resale by the Trione Family Trusts lapse. A decline in the price of our common stock might impede our ability to raise capital through the issuance of additional common stock or other equity securities.
Short sellers of our stock may be manipulative and may drive down the market price of our common stock.
Short selling is the practice of selling securities that the seller does not own but rather has borrowed or intends to borrow from a third party with the intention of buying identical securities at a later date to return to the lender. A short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller’s interest for the price of the stock to decline, some short sellers publish, or arrange for the publication of, opinions or characterizations regarding the relevant issuer, its business practices and prospects and similar matters calculated to or which may create negative market momentum, which may permit them to obtain profits for themselves as a result of selling the stock short. Issuers whose securities have historically had limited trading volumes and/or have been susceptible to relatively high volatility levels can be particularly vulnerable to such short seller attacks. The publication of any such commentary regarding us in the future may bring about a temporary, or possibly long term, decline in the market price of our common stock. When the market price of a company's stock drops significantly, it is not unusual for stockholder lawsuits to be filed or threatened against the company and its board of directors and for a company to suffer reputational damage. Such lawsuits could cause us to incur substantial costs and divert the time and attention of our board and management. In addition, reputational damage to the Company may affect our ability to attract and retain deposits and may cause our deposit costs to increase, which could adversely affect our liquidity and earnings. Reputational damage may also affect our ability to attract and retain loan customers and maintain and develop other business relationships, which could likewise adversely affect our earnings. Negative reports issued by short sellers could also negatively impact our ability to attract and retain employees.
Trading in our common stock has been moderate. As a result, shareholders may not be able to quickly and easily sell their common stock, particularly in large quantities.
Although our common stock is listed for trading on NASDAQ and a number of brokers offer to make a market in our common stock on a regular basis, trading volume to date has been moderate, averaging 137,223 shares per trading day from January 2, 2018 through March 9, 2018. There can be no assurance that a more active and liquid market for our common stock will develop or can be maintained. As a result, shareholders may find it difficult to sell a significant number of shares of our common stock at the prevailing market price.
We are an "emerging growth company," as defined in the JOBS Act and will be able to avail ourselves of reduced disclosure requirements applicable to emerging growth companies, which could make our common stock less attractive to investors and adversely affect the market price of our common stock.
We are an "emerging growth company," as defined in the JOBS Act. For as long as we continue to be an emerging growth company we may take advantage of certain exemptions from various requirements generally applicable to public companies. These include, without limitation, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced financial reporting requirements, reduced disclosure obligations regarding executive compensation, and exemption from requirements of holding non-binding advisory votes on executive compensation and golden parachute payments. The JOBS Act also permits an emerging growth company such as us to take advantage of an extended transition period to comply with the new or revised accounting standards applicable to public companies. We have elected not to opt out of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard. We do, however, have the option to early adopt an individual standard where early adoption is permitted by the Financial Accounting Standards Board (“FASB”). The election not to opt out of the extended transition period may cause our financial condition and results of operations to be less comparable to those of other companies.
We may take advantage of these exemptions until we are no longer an emerging growth company. We would cease to be an emerging growth company upon the earliest of: (i) the first fiscal year following the fifth anniversary of our initial public offering; (ii) the first fiscal year after our annual gross revenues are $1.07 billion or more; (iii) the date on which we have during the previous three-year period, issued more than $1 billion in non-convertible debt securities; or (iv) as of the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeds $700 million as of the end of the second quarter of that fiscal year.
We cannot predict whether investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may a less active trading market for our common stock, and our stock price may be more volatile or decline.
There are substantial regulatory limitations on changes of control of bank holding companies that may discourage investors from purchasing shares of our common stock.
With limited exceptions, federal regulations prohibit a person or company or a group of persons deemed to be "acting in concert" from, directly or indirectly, acquiring more than 10% (5% if the acquirer is a bank holding company) of any class of our voting stock or obtaining the ability to control in any manner the election of a majority of the directors or otherwise direct the management or policies of our company without prior notice or application to, and the approval of, the Federal Reserve. Companies investing in banks and bank holding companies receive additional review and may be required to become bank holding companies, subject to regulatory supervision. Accordingly, prospective investors must be aware of and comply with these requirements, if applicable, in connection with any purchase of shares of our common stock. These provisions could discourage third parties from seeking to acquire significant interests in us or in attempting to acquire control of us, which, in turn, could adversely affect the market price of our common stock.
The requirements of being a public company may strain our resources and divert management's attention, particularly after we are no longer an "emerging growth company." Any deficiencies in our financial reporting or internal controls could materially and adversely affect our business and the market price of our common stock.
As a public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and applicable securities rules and regulations. These laws and regulations increase the scope, complexity and cost of corporate governance, reporting and disclosure practices to which we are subject. Despite our conducting business in a highly regulated environment, these laws and regulations have different requirements for compliance than we had experienced prior to becoming a public company. Among other things, the Exchange Act requires that we file annual, quarterly and current reports with respect to our business and operating results and maintain effective disclosure controls and procedures and internal control over financial reporting. As a NASDAQ listed company, we are required to prepare and file proxy materials which meet the requirements of the Exchange Act and the SEC's proxy rules. Compliance with these rules and regulations has and will likely continue to increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly, and increase demand on our systems and
resources, particularly after we are no longer an "emerging growth company" as defined in the JOBS Act. Beginning with the time we are no longer an "emerging growth company" as defined in the JOBS Act, but no later than December 31, 2022, we will be required to engage our independent registered public accounting firm to audit and opine on the design and operating effectiveness of our internal control over financial reporting. This process will require significant documentation of policies, procedures and systems, and review of that documentation and testing of our internal control over financial reporting by our internal auditing and accounting staff and our independent registered public accounting firm. This process will require considerable time and attention from management, which could prevent us from successfully implementing our business initiatives and improving our business, financial condition and results of operations, any strain our internal resources, and will increase our operating costs. We may experience higher than anticipated operating expenses and outside auditor fees during the implementation of these changes and thereafter.
During the course of our testing we may identify deficiencies that would have to be remediated to satisfy the SEC rules for certification of our internal control over financial reporting. A material weakness is defined by the standards issued by the PCAOB as a deficiency, or combination of deficiencies, in internal control over financial reporting that results in a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As a consequence, we would have to disclose in periodic reports we file with the SEC any material weakness in our internal control over financial reporting. The existence of a material weakness would preclude management from concluding that our internal control over financial reporting is effective and would preclude our independent auditors from expressing an unqualified opinion on the effectiveness of our internal control over financial reporting. In addition, disclosures of deficiencies of this type in our SEC reports could cause investors to lose confidence in our financial reporting, and may negatively affect the market price of our common stock, and could result in the delisting of our securities from the securities exchanges on which they trade. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we have deficiencies in our disclosure controls and procedures or internal control over financial reporting, it may materially and adversely affect us.
We may not pay dividends on our common stock in the future.
Holders of our common stock are entitled to receive only such dividends as our board of directors may declare out of funds legally available for such payments. Our board of directors may, in its sole discretion, change the amount or frequency of dividends or discontinue the payment of dividends entirely. In addition, we are a bank holding company, and our ability to declare and pay dividends is dependent on federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends. It is the policy of the Federal Reserve that bank holding companies should generally pay dividends on common stock only out of earnings, and only if prospective earnings retention is consistent with the organization's expected future needs, asset quality and financial condition.
We are controlled by trusts established for the benefit of members of the Trione family, whose interests in our business may be different from yours.
The As of December 31, 2022, the Trione Family Trusts currently control 70.9%78.4% of our common stock and if they vote in the same manner, are able to determine the outcome of all matters put to a shareholder vote, including the election of directors, the approval of mergers, material acquisitions and dispositions and other extraordinary transactions, and amendments to our articles of incorporation, bylaws and other corporate governance documents. So long as the Trione Family Trusts continue to own a majority of our common stock, they will have the ability, if they vote in the same manner, to approve or prevent any transaction that requires shareholder approval regardless of whether others believe the transaction is in our best interests. In any of these matters, the interests of the Trione Family Trusts may differ from or conflict with the interests of our other shareholders. Moreover, this concentration of stock ownership may also adversely affect the trading price of our common stock, if investors perceive disadvantages in owning stock of a company with a controlling family.
We are a "controlled company" within the meaning of the rules of NASDAQ and, as a result, qualify for, and may rely on, exemptions from certain corporate governance requirements. As a result, you will not have the same protections afforded to shareholders of companies that are subject to such requirements.
We are a "controlled company" within the meaning of the corporate governance standards of NASDAQ. Under these rules, a company of which more than 50% of the voting power is held by an individual, group or another company is a "controlled company" and may elect not to comply with certain corporate governance requirements, including the requirements that a majority of the board of directors consist of independent directors and to have board-level compensation and nominating and corporate governance committees consisting entirely of independent directors.
We do not intend to rely on these exemptions, but we may, in the future, take advantage of some of these exemptions for as long as we continue to qualify as a "controlled company." Accordingly, our shareholders may not have the same protections afforded to shareholders of companies that are subject to all of the corporate governance requirements of NASDAQ.
We may issue additional equity securities, or engage in other transactions, which could affect the priority of our common stock, which may adversely affect the market price of our common stock.
Our board of directors may determine from time to time that we need to raise additional capital by issuing additional shares of our common stock or other securities. We are not restricted from issuing additional shares of common stock, including securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of any future offerings, or the prices at which such offerings may be effected. Such offerings could be dilutive to common shareholders. We may also issue shares of preferred stock that will provide new investors with rights, preferences and privileges that are senior to, and that adversely affect, our then current common shareholders. Additionally, if we raise additional capital by making additional offerings of debt or preferred equity securities, upon liquidation, holders of our debt securities and shares of preferred stock, and lenders with respect to other borrowings, will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution.
In connection with our initial public offering, we entered into a tax sharing agreement with those shareholders who owned our stock immediately prior to the initial public offering (collectively, "S Corp. Shareholders"), and under this agreement, we could become obligated to make payments to our S Corp. Shareholders for any additional federal, state or local income taxes assessed against them for tax periods prior to our initial public offering.
Prior to our initial public offering, we were an S Corporation for U.S. federal income tax purposes. While we were an S Corporation, our S Corp. Shareholders as individuals were taxed on our income. Therefore, our S Corp. Shareholders received certain distributions ("tax distributions") from us that were generally intended to equal the amount of tax our S Corp. Shareholders were required to pay with respect to our income. In connection with our initial public offering, our S Corporation was terminated and we thereafter became subject to federal and increased state income taxes. In the event of an adjustment to our reported taxable income for periods prior to termination of our S Corporation status, it is possible that our S Corp. Shareholders would be liable for additional income taxes for those prior periods. Therefore, we entered into a tax sharing agreement with our S Corp. Shareholders. Pursuant to this agreement, upon our filing of any tax return (amended or otherwise), in the event of any restatement of our taxable income 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 our S Corp. Shareholders in an amount equal to our S Corp. Shareholders' incremental tax liability, which amount may be material. In addition, we will indemnify our S Corp. Shareholders with respect to unpaid income tax liabilities 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 terminates. In both cases the amount of the payment will be based on the assumption that our S Corp. Shareholders are taxed at the highest rate application to married individuals filing jointly for the relevant periods. We will also indemnify our S Corp. Shareholders for any interest, penalties, losses, costs or expenses arising out of any claim under the agreement. However, our S Corp. Shareholders will indemnify us with respect to our unpaid tax liabilities (including interest and penalties) to the extent that such unpaid tax liabilities are attributable to a decrease in our S Corp. Shareholders' taxable income for any tax period and a corresponding increase in our taxable income for any period.
In connection with this tax sharing agreement and the filing of our final S Corporation income tax return for the period ending November 30, 2017, the Company expects to pay a dividend of $5.2 million to the S Corp. Shareholders in the first quarter of 2018 for the taxable income that will be passed through to them and for which they have not previously received payment.
Prior to our initial public offering, we were treated as an S Corporation, and claims of taxing authorities related to our prior status as an S Corporation could adversely affect us.
Following our initial public offering, our status as an S Corporation was terminated and we became a "C Corporation" under the provisions of Sections 301 through 385 of the Code. If the unaudited, open tax years in which we were an
S Corporation are audited by the Internal Revenue Service, or IRS, and we are determined not to have qualified for, or to have violated any requirement for maintaining, our S Corporation status, we will be obligated to pay back taxes, interest and penalties. The amounts that we would be obligated to pay could include taxes on all our taxable income while we were an S Corporation. Any such claims could result in additional costs to us and could have a material adverse effect on our business, financial condition or results of operations.
Future equity issuances could result in dilution, which could cause our common stock price to decline and future sales of our common stock could depress the market price of our common stock.
Our charter permits us to issue up to an aggregate of 100 million shares of common stock. As of December 31, 2017, 56,422,662 shares of our common stock were issued and outstanding. An additional 2,689,699 shares have been reserved for future issuance pursuant to the LBC Omnibus Equity and Incentive Compensation Plan. Our charter permits us to issue up to an aggregate of 5 million shares of preferred stock. A future issuance of any new shares of our common stock would, and equity-related securities could, cause further dilution in the value of our outstanding shares of common stock.
We have the ability to incur debt and pledge our assets, including stock in our bank, to secure that debt.
We have the ability to incur debt and pledge our assets to secure that debt. Absent special and unusual circumstances, a holder of indebtedness for borrowed money has rights that are superior to those of holders of our common stock. For example, interest must be paid to a lender before dividends can be paid to our shareholders, and, in the case of liquidation, our borrowings must be repaid before we can distribute any assets to our shareholders. Furthermore, we would have to make principal and interest payments on our indebtedness, which could reduce our profitability or result in net losses on a consolidated basis even if our Bank were profitable.
Our corporate governance documents, and corporate and banking laws applicable to us, could make a takeover more difficult and adversely affect the market price of our common stock.
Certain provisions of our articles of incorporation and bylaws, and corporate and federal banking laws, could delay, defer, or prevent a third party from acquiring control of our organization or conducting a proxy contest, even if those events were perceived by many of our shareholders as beneficial to their interests. These provisions and regulations applicable to us:
enable our board of directors to issue additional shares of authorized, but unissued capital stock;
enable our board of directors to issue "blank check" preferred stock with such designations, rights and preferences as may be determined from time to time by the board;
trading volumes do not provide for cumulative voting rights;sufficient liquidity.
enable our board of directors to amend our bylaws without stockholder approval;
limit the right of shareholders to call a special meeting;
require advance notice for director nominations and other stockholder proposals; and
require prior regulatory application and approval of any transaction involving control of our organization.
These provisions may discourage potential acquisition proposals and could delay or prevent a change in control, including under circumstances in which our shareholders might otherwise receive a premium over the market price of our shares. In addition, as of the date hereof, the Trione Family Trusts will own shares sufficient for the majority vote over all matters requiring a stockholder vote, which may delay, deter or prevent acts that would be favored by our other shareholders.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our corporate headquarters is located at 520 Third Street, Santa Rosa, California. In addition to our corporate headquarters, the Bank operates nine branch officesten full service branches in California located in Beverly Hills, Burbank, Encino, Long BeachSonoma, Marin, Santa Clara, and Pasadena, each in Los Angeles County, California, San Rafael,Counties and one full service branch in Marin County, California, Los Altos and San Jose, eachWashington located in Santa Clara County, California, and Santa Rosa, in Sonoma County, California.King County. We also operate nine lendingseveral loan production offices in the cities of Roseville, Santa Rosa, Emeryville, Walnut Creek, Manhattan Beach, Irvine and Solana Beach in California, Seattle, Washington and, since November 1, 2017, Portland, Oregon.located throughout California. Other than our main branch in Santa Rosa, California, which we own, we lease all of our other offices.
Item 3. Legal Proceedings
From time to time, we are a party to legal actions that are routine and incidental to our business. Given the nature, scope and complexity of the extensive legal and regulatory landscape applicable to our business, including laws and regulations governing consumer protections, fair lending, fair labor, privacy, information security and anti-money laundering and anti-terrorism laws, we, like all banking organizations, are subject to heightened legal and regulatory compliance and litigationlegal risk. However, based uponon available information, and in consultation with legal counsel, management does not expect the ultimate disposition of any or a combination of these actions to have a material adverse effect on our business, prospects, financial condition liquidity,or results of operation, cash flows or capital levels.operation.
Item 4. Mine Safety Disclosures
Not applicable.
PART II.
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Holders of Record
On December 8, 2017, ourOur common stock becameis listed and commenced trading on the NASDAQ Global Select Stock Market under the trading symbol "LBC". Prior to that time, there was no established public trading market for our stock. As of December 31, 2017,February 17, 2023, we had approximately 1,100 beneficial owners.3,005 record holders. On December 29, 2017, the last trading day in the fiscal year,February 17, 2023, our stock closed at $12.04.
The following table shows the high and low sales price and the dividends declared of the Company’s common stock for each full quarter in 2017 as reported on the NASDAQ Global Select Stock Market.
|
| | | | | | | |
| Year Ended December 31, 2017 |
| High | | Low |
Quarter ended March 31, 2017 | N/A |
| | N/A |
|
Quarter ended June 30, 2017 | N/A |
| | N/A |
|
Quarter ended September 30, 2017 | N/A |
| | N/A |
|
Quarter ended December 31, 2017 (beginning December 8, 2017) | $ | 12.67 |
| | $ | 11.50 |
|
$12.17.
Stock Performance Graph
The performance graph and table below comparescompare the cumulative total stockholder return on the common stock of the Company with the cumulative total return on the equity securities included in (i) the Russell 2000 Index, which measures the performance of the smallest 2,000 members by market cap of the Russell Index, and (ii) the KBW Nasdaq Regional BankingS&P U.S. BMI Banks - Western Region Index, ("KRX"), which reflects the performance of publicly traded U.S. companies that do business as regional banks or thrifts.in the Western U.S., and (iii) the S&P U.S. BMI Banks Index, which reflects the performance of publicly traded U.S. banks that do business in the U.S.
The graph below assumes an initial $100 investment on December 8,31, 2017 the date that the stock of the Company began trading on the NASDAQ Global Select Stock Market through December 29, 2017, the final trading day of 2017.31, 2022. Data for the Company, the Russell 2000, the S&P U.S. BMI Banks - Western Region and the KBW Nasdaq Regional Banking IndexS&P U.S. BMI Banks indices assume reinvestment of dividends. Returns are shown on a total return basis. The performance graph represents past performance and should not be considered to be an indication of future performance. This graph is not deemed filed with the SEC.
| | | | | | | | | | | | | | | | | | | | | |
| | Period Ended |
Index | | 12/31/2017 | 12/31/2018 | 12/31/2019 | 12/31/2020 | 12/31/2021 | 12/31/2022 |
Luther Burbank Corporation | | 100.00 | | 76.21 | | 99.57 | | 86.64 | | 127.66 | | 104.87 | |
Russell 2000 Index | | 100.00 | | 88.99 | | 111.7 | | 134.00 | | 153.85 | | 122.41 | |
S&P U.S. BMI Banks - Western Region | | 100.00 | | 79.17 | | 96.55 | | 72.25 | | 111.40 | | 86.45 | |
S&P U.S. BMI Banks | | 100.00 | | 83.54 | | 114.74 | | 100.10 | | 136.10 | | 112.89 | |
| | | | | | | |
Source: S&P Capital IQ Pro | | | | |
Dividend Policy
Holders of our common stock are only entitled to receive dividends when, as and if, declared by our board of directors out of funds legally available for dividends.
Prior to our initial public offering, we were an S corporation for U.S. federal income tax purposes. As an S Corporation, we historically made distributions to our shareholders to provide them with funds to pay U.S. federal income tax on their taxable income that was “passed through” to them, as well as additional amounts for returns on capital. Following our initial public offering, our board of directors declared a cash dividend to our shareholders that existed prior to the offering in the amount of $40.0 million, which was intended to be non-taxable to them and represented a significant portion of our S Corporation earnings that have been, or will be, taxed to our shareholders, but not distributed to them. The Company also declared a cash dividend to our shareholders that existed prior to the offering in the amount of $7.1 million on December 1, 2017 to fund the payment of the estimated fourth quarter 2017 taxes that will be ‘‘passed through’’ to them by virtue of our status as an S Corporation. Purchasers of our common stock in the initial public offering were not entitled to receive any portion of these distributions.
The following table shows the dividends that have been declared on our common stock with respect to the periods indicated below. The per share amounts set forth in the following table have been adjusted to give effect to the 200-for-one stock split effective as of April 27, 2017. The per share amounts are presented to the nearest cent.
|
| | | | | | | |
(dollars in thousands, except share amounts and per share data) | Amount per share | | Total cash dividend |
Quarter ended March 31, 2016 | $ | 0.06 |
| | $ | 2,500 |
|
Quarter ended June 30, 2016 | 0.14 |
| | 5,700 |
|
Quarter ended September 30, 2016 | 0.10 |
| | 4,100 |
|
Quarter ended December 31, 2016 | 0.11 |
| | 4,500 |
|
Quarter ended March 31, 2017 | 0.23 |
| | 9,800 |
|
Quarter ended June 30, 2017 | 0.25 |
| | 10,400 |
|
Quarter ended September 30, 2017 | 0.01 |
| | 500 |
|
Quarter ended December 31, 2017 | 1.12 |
| | 47,100 |
|
Future Dividend Policy
Following our initial public offering and our conversion to a C corporation, our dividend policy and practice has changed. Outside of our existing obligations under our tax sharing agreement with prior S Corp. Shareholders as set forth in the “Risk Factors” section of this Annual Report, we will no longer pay distributions to our shareholders to pay U.S. federal income taxes on their pro rata portion of our taxable income.
Any future determination relating to our dividend policy will be made by our board of directors and will depend on a number of factors, including general and economic conditions, industry standards, our financial condition and operating results, our available cash and current and anticipated cash needs, capital requirements, our ability to service debt obligations senior to our common stock, banking regulations, contractual, legal, tax and regulatory restrictions, and limitations on the payment of dividends by us to our shareholders or by the Bank to us, and such other factors as our board of directors may deem relevant.
Because we are a bank holding company and do not engage directly in business activities of a material nature, our ability to pay any dividends on our common stock depends, in large part, upon our receipt of dividends from our Bank, which is also subject to numerous limitations on the payment of dividends under federal and state banking laws, regulations and policies.
The Company declared and paid a dividend inDividends are authorized at the first quarter of 2018 of $0.015 per share, which was a prorated amount based on the portion of the fourth quarter of 2017 during which the Company was a public company, which was 24 days. Subject to thesole discretion of our board of directors and the considerations discussed under ‘‘Market for Common Stock and Dividend Policy,’’ commencing in the second quarter of 2018, the Company expects to establish a regular quarterly cash dividend ondirectors. In addition, our common stock of $0.0575 per share. Although we currently intend to pay dividends according to our dividend policy, there can be no assurance that we will pay any dividend to holders of our stock, or as to the amount of any such dividends. Our board of directors in its sole discretion, can change the amount or frequency of this dividend or discontinue the payment of dividends entirely at any time.
In connection Given the pending merger with our tax sharing agreement with our S Corp. ShareholdersWAFD, and the filingdesire to preserve capital in the current uncertain economic environment, the Company’s board of directors, on January 24, 2023, decided to suspend any further quarterly cash dividends. The following table shows the dividends that have been declared on our final S Corporation income tax return for the period ending November 30, 2017, the Company expects to pay a dividend of $5.2 millioncommon stock with respect to the S Corp. Shareholders inperiods indicated below. The per share amounts are presented to the first quarter of 2018 for the taxable income that will be passed through to them and for which they have not previously received payment.nearest cent.
| | | | | | | | | | | |
(dollars in thousands, except per share data) | Amount Per Share | | Total Cash Dividend |
Quarter ended March 31, 2021 | $ | 0.06 | | | $ | 3,009 | |
Quarter ended June 30, 2021 | 0.06 | | | 3,006 | |
Quarter ended September 30, 2021 | 0.12 | | | 6,217 | |
Quarter ended December 31, 2021 | 0.12 | | | 6,214 | |
Quarter ended March 31, 2022 | 0.12 | | | 6,225 | |
Quarter ended June 30, 2022 | 0.12 | | | 6,126 | |
Quarter ended September 30, 2022 | 0.12 | | | 6,139 | |
Quarter ended December 31, 2022 | 0.12 | | | 6,138 | |
Dividend Limitations. California law places limits on the amount of dividends the Bank may pay to the Company without prior approval. Prior regulatory approval is required to pay dividends which exceed the lesser of the Bank’s retained earnings or the Bank’s net profits for that year combined with the retained net incomeprofits for the prior three fiscalpreceding two years. State and federal bank regulatory agencies also have authority to prohibit a bank from paying dividends if such payment is deemed to be an unsafe or unsound practice, and the Federal Reserve has the same authority over bank holding companies. We would not be able to pay a dividend in excess of our retained earnings, or where our liabilities would exceed our assets.
The Federal Reserve has established requirements with respect to the maintenance of appropriate levels of capital by registered bank holding companies. Compliance with such standards, as presently in effect, or as they may be amended from time to time, could possibly limit the amount of dividends that we may pay in the future. The Federal Reserve has issued guidance on the payment of cash dividends by bank holding companies. In the statement, the
Federal Reserve expressed its view that a holding company experiencing earnings weaknesses should not pay cash
dividends exceeding its net income, or which could only be funded in ways that weaken the holding company’s financial health, such as by borrowing. Under Federal Reserve guidance, as a general matter, the board of directors of a holding company should inform the Federal Reserve and should eliminate, defer, or significantly reduce the dividends if: (i) the holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the holding company’s prospective rate of earnings retention is not consistent with theits capital needs and overall current and prospective financial condition; or (iii) the holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. As a depository institution, the deposits of which are insured by the FDIC, the Bank may not pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Bank currently is not in default under any of its obligations to the FDIC.
Shares Eligible for Sale Pursuant to Rule 144
UseAn aggregate of Proceeds
On December 7, 2017, our registration statement on Form S-1 (Registration No. 333-221455) was declared effective35.8 million shares of common stock held by the SECTrione Family Trusts, which were issued in private transactions, are eligible for our underwritten initial public offeringsale in which we sold a total of 13,972,500 shares of our common stock at a price to the public of $10.75 per share. Keefe, Bruyette & Woods, Inc. and Sandler O’Neill & Partners, L.P. acted as the joint book-running managers for the offering, Piper, Jaffrey & Co. acted as lead manager and D.A. Davidson & Co. acted as co-manager. The offering commenced on December 7, 2017 and closed on December 12, 2017. Of the $163,156,250 of shares registered pursuant to the registration statement, $150,204,375 were sold. No further securities will be sold pursuant to the offering. We received net proceeds of approximately $138.3 million after deducting underwriting discounts and commissions of $9.8 million and other offering expenses of $2.1 million. No paymentsaccordance with respect to expenses were made by us to directors, officers or persons owning ten percent or more of either class of our common stock or to their associates, or to our affiliates. However, as described in the Prospectus relating to the offering, $40.0 million of the net proceeds from the offering were used to fund a cash distribution to our pre-initial public offering shareholders, which cash distribution was intended to be non-taxable to them. The balance of the proceeds for the offering was contributed to the Bank as capital, where they were used to pay down Federal Home Loan Bank borrowings. There has been no material change in the planned use of proceeds from our initial public offering as described in the Prospectus filed with the SEC on December 8, 2017.
Issuer Repurchase of Common Stock
No shares of the Company's common stock were repurchased by or on behalf of the Company since the date the Company’s common stock became registeredRule 144 under Section 12 of the Securities Exchange Act of 1934.Act.
Securities Authorized for Issuance under Equity Compensation Plans
The information regarding the Company’s equity compensation plan is contained under “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” of this Form 10-K and is incorporated by reference herein.
Item 6. Selected Financial Data
The following table sets forth the Company’s selected historical consolidated financial data for the periodsyears and as of the dates indicated. You should read this information together with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s audited consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of and for the years ended December 31, 2017, 20162022 and 20152021 are derived from our audited consolidated financial statements, which are included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of and for the years ended December 31, 20142020, 2019 and 20132018 (except as otherwise noted below) are derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The Company’s historical results for any prior period are not necessarily indicative of future performance.
|
| | | | | | | | | | | | | | | | | | | | | |
| | As of or for the Years Ended December 31, |
(Dollars in thousands, except share/per share data and percentages) | | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
Statements of Income Data | | | | | | | | | | |
Total interest income | | $ | 174,287 |
| | $ | 144,159 |
| | $ | 127,546 |
| | $ | 131,289 |
| | $ | 136,538 |
|
Total interest expense | | 63,342 |
| | 49,524 |
| | 42,633 |
| | 37,290 |
| | 32,728 |
|
Net interest income | | 110,945 |
| | 94,635 |
| | 84,913 |
| | 93,999 |
| | 103,810 |
|
(Reversal of) provision for loan losses | | (3,372 | ) | | (12,703 | ) | | (7,141 | ) | | — |
| | 7,500 |
|
Total noninterest income | | 7,458 |
| | 7,844 |
| | 6,924 |
| | 3,608 |
| | 1,816 |
|
Total noninterest expense | | 56,544 |
| | 61,242 |
| | 62,339 |
| | 61,886 |
| | 43,953 |
|
Net income before income taxes | | 65,231 |
| | 53,940 |
| | 36,639 |
| | 35,721 |
| | 54,173 |
|
Income tax (benefit) expense | | (4,153 | ) | | 1,819 |
| | 1,247 |
| | 1,118 |
| | 1,394 |
|
Net income | | $ | 69,384 |
| | $ | 52,121 |
| | $ | 35,392 |
| | $ | 34,603 |
| | $ | 52,779 |
|
Pre-tax, pre-provision net earnings (1) | | $ | 61,859 |
| | $ | 41,237 |
| | $ | 29,498 |
| | $ | 35,721 |
| | $ | 61,673 |
|
Per Common Share (2) | | | | | | | | | | |
Basic earnings per share | | $ | 1.62 |
| | $ | 1.24 |
| | $ | 0.84 |
| | $ | 0.82 |
| | $ | 1.26 |
|
Diluted earnings per share | | $ | 1.62 |
| | $ | 1.24 |
| | $ | 0.84 |
| | $ | 0.82 |
| | $ | 1.26 |
|
Book value per share | | $ | 9.74 |
| | $ | 9.63 |
| | $ | 8.84 |
| | $ | 8.32 |
| | $ | 7.89 |
|
Tangible book value per share (1) | | $ | 9.68 |
| | $ | 9.55 |
| | $ | 8.76 |
| | $ | 8.24 |
| | $ | 7.81 |
|
Common shares outstanding at end of period | | 56,422,662 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
|
Weighted average shares outstanding - basic | | 42,916,879 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
|
Weighted average shares outstanding - diluted | | 42,957,936 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
|
Pro Forma Statements of Income and Per Common Share Data (1) | | | | | | | | | | |
Pro forma provision for income tax | | $ | 27,397 |
| | $ | 22,655 |
| | $ | 15,388 |
| | $ | 15,003 |
| | $ | 22,753 |
|
Pro forma net income | | 37,834 |
| | 31,285 |
| | 21,251 |
| | 20,718 |
| | 31,420 |
|
Pro forma net income per common share—basic | | $ | 0.88 |
| | $ | 0.74 |
| | $ | 0.51 |
| | $ | 0.49 |
| | $ | 0.75 |
|
Pro forma net income per common share—diluted | | $ | 0.88 |
| | $ | 0.74 |
| | $ | 0.51 |
| | $ | 0.49 |
| | $ | 0.75 |
|
Selected Balance Sheet Data | | | | | | | | | | |
Cash and due from banks | | $ | 75,578 |
| | $ | 59,208 |
| | $ | 65,562 |
| | $ | 145,084 |
| | $ | 63,427 |
|
Held-to-maturity securities | | 6,921 |
| | 7,561 |
| | 9,331 |
| | 6,736 |
| | 7,345 |
|
Available-for-sale securities, fair value | | 503,288 |
| | 459,162 |
| | 377,669 |
| | 312,367 |
| | 169,517 |
|
Loans held-for-investment (3) | | 5,041,547 |
| | 4,439,766 |
| | 3,855,503 |
| | 3,472,422 |
| | 3,397,411 |
|
Allowance for loan losses | | (30,312 | ) | | (33,298 | ) | | (45,509 | ) | | (52,508 | ) | | (55,217 | ) |
Loans held for sale | | — |
| | 34,974 |
| | 18,086 |
| | 4,980 |
| | — |
|
Total assets | | 5,704,380 |
| | 5,063,585 |
| | 4,361,779 |
| | 3,969,047 |
| | 3,659,069 |
|
Total deposits | | 3,951,238 |
| | 3,333,969 |
| | 3,121,247 |
| | 3,145,774 |
| | 3,106,596 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands, except per share data) | | As of or For the Years Ended December 31, |
| 2022 | | 2021 | | 2020 | | 2019 | | 2018 |
Statements of Income and Financial Condition Data |
Net income | | $ | 80,198 | | | $ | 87,753 | | | $ | 39,912 | | | $ | 48,861 | | | $ | 45,060 | |
Pre-tax, pre-provision net earnings (1) | | $ | 114,887 | | | $ | 113,200 | | | $ | 67,209 | | | $ | 70,714 | | | $ | 66,531 | |
Total assets | | $ | 7,974,632 | | | $ | 7,179,957 | | | $ | 6,906,104 | | | $ | 7,045,828 | | | $ | 6,937,212 | |
Per Common Share | | | | | | | | | | |
Diluted earnings per share | | $ | 1.57 | | | $ | 1.70 | | | $ | 0.75 | | | $ | 0.87 | | | $ | 0.79 | |
Book value per share | | $ | 13.36 | | | $ | 12.95 | | | $ | 11.75 | | | $ | 10.97 | | | $ | 10.31 | |
Tangible book value per share (1) | | $ | 13.30 | | | $ | 12.88 | | | $ | 11.69 | | | $ | 10.91 | | | $ | 10.25 | |
|
| | | | | | | | | | |
| | | | | | | | | | |
Selected Ratios | | | | | | | | | | |
Return on average: | | | | | | | | | | |
Assets | | 1.06 | % | | 1.22 | % | | 0.56 | % | | 0.69 | % | | 0.70 | % |
Stockholders' equity | | 11.84 | % | | 13.64 | % | | 6.53 | % | | 8.15 | % | | 7.96 | % |
Dividend payout ratio | | 30.71 | % | | 21.02 | % | | 30.85 | % | | 26.67 | % | | 35.43 | % |
Net interest margin | | 2.39 | % | | 2.40 | % | | 1.97 | % | | 1.84 | % | | 1.98 | % |
Efficiency ratio (1) | | 35.79 | % | | 34.32 | % | | 52.38 | % | | 46.86 | % | | 48.51 | % |
Noninterest expense to average assets | | 0.85 | % | | 0.82 | % | | 1.04 | % | | 0.88 | % | | 0.98 | % |
Loan to deposit ratio | | 120.06 | % | | 113.71 | % | | 114.92 | % | | 119.03 | % | | 122.59 | % |
| | | | | | | | | | |
| | | | | | | | | | |
| | | | | | | | | | |
Credit Quality Ratios | | | | | | | | | | |
Allowance for loan losses to loans | | 0.52 | % | | 0.56 | % | | 0.76 | % | | 0.58 | % | | 0.56 | % |
Allowance for loan losses to nonperforming loans | | 566.91 | % | | 1,549.72 | % | | 732.04 | % | | 568.47 | % | | 1,705.47 | % |
Nonperforming assets to total assets | | 0.08 | % | | 0.03 | % | | 0.09 | % | | 0.09 | % | | 0.03 | % |
Net (recoveries) charge-offs to average loans | | — | % | | (0.00) | % | | 0.01 | % | | (0.01) | % | | (0.01) | % |
Capital Ratios | | | | | | | | | | |
Tier 1 leverage ratio | | 9.72 | % | | 10.12 | % | | 9.45 | % | | 9.47 | % | | 9.42 | % |
Total risk-based capital ratio | | 19.14 | % | | 19.61 | % | | 18.60 | % | | 17.97 | % | | 17.20 | % |
| | | | | | | | | | |
(1) Considered a non-GAAP financial measure. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ‘‘Non-GAAP Financial Measures’’ for a reconciliation of our non-GAAP measures to the most directly comparable GAAP financial measure. Pre-tax, pre-provision net earnings is defined as net income before taxes and provision for loan losses. Tangible book value is defined as total assets less goodwill and total liabilities. Efficiency ratio is defined as the ratio of noninterest expense to net interest income plus noninterest income. |
|
|
| | | | | | | | | | | | | | | | | | | | | |
Borrowings | | 1,145,278 |
| | 1,267,771 |
| | 824,062 |
| | 433,479 |
| | 183,027 |
|
Total stockholders' equity | | 549,745 |
| | 404,375 |
| | 371,299 |
| | 349,508 |
| | 331,397 |
|
Selected Ratios | | | | | | | | | — |
| |
Return on average: | | | | | | | | | | |
Assets (4) | | 1.26 | % | | 1.11 | % | | 0.88 | % | | 0.91 | % | | 1.45 | % |
Stockholders' equity (4) | | 16.30 | % | | 13.35 | % | | 9.85 | % | | 10.08 | % | | 16.16 | % |
Average stockholders' equity to average assets (4) | | 7.76 | % | | 8.35 | % | | 8.89 | % | | 9.05 | % | | 9.00 | % |
Net interest margin | | 2.05 | % | | 2.04 | % | | 2.11 | % | | 2.49 | % | | 2.88 | % |
Efficiency ratio (1) | | 47.76 | % | | 59.76 | % | | 67.88 | % | | 63.40 | % | | 41.61 | % |
Loan to deposit ratio | | 127.59 | % | | 134.22 | % | | 124.10 | % | | 110.54 | % | | 109.36 | % |
Yield on interest-earning assets | | 3.22 | % | | 3.11 | % | | 3.17 | % | | 3.48 | % | | 3.78 | % |
Cost of interest-bearing liabilities | | 1.27 | % | | 1.17 | % | | 1.17 | % | | 1.09 | % | | 1.00 | % |
Cost of total deposits | | 1.05 | % | | 0.99 | % | | 0.95 | % | | 0.85 | % | | 0.80 | % |
Pro Forma Selected Ratios (1) (4) | | | | | | | | | | |
Pro forma return on average assets | | 0.69 | % | | 0.67 | % | | 0.53 | % | | 0.55 | % | | 0.87 | % |
Pro forma return on average equity | | 8.89 | % | | 8.02 | % | | 5.91 | % | | 6.03 | % | | 9.62 | % |
Credit Quality Ratios | | | | | | | | | | |
Allowance for loan losses to loans | | 0.60 | % | | 0.75 | % | | 1.18 | % | | 1.51 | % | | 1.63 | % |
Allowance for loan losses to nonperforming loans | | 430.75 | % | | 1,260.81 | % | | 710.97 | % | | 534.81 | % | | 250.90 | % |
Nonperforming assets to total assets | | 0.12 | % | | 0.05 | % | | 0.15 | % | | 0.25 | % | | 0.60 | % |
Net (charge offs) recoveries to average loans | | 0.01 | % | | 0.01 | % | | — | % | | (0.08 | )% | | (0.24 | )% |
Capital Ratios (Company) (5) | | | | | | | | | | |
Stockholders' equity to assets | | 9.64 | % | | 7.99 | % | | 8.51 | % | | 8.81 | % | | 9.06 | % |
Tier 1 leverage ratio | | 11.26 | % | | 9.47 | % | | 10.22 | % | | 10.27 | % | | 10.62 | % |
Tier 1 risk-based capital ratio | | 17.84 | % | | 17.33 | % | | 19.00 | % | | 19.18 | % | | 18.60 | % |
Total risk-based capital ratio | | 18.78 | % | | 18.58 | % | | 20.26 | % | | 20.45 | % | | 19.87 | % |
Common Equity Tier 1 ratio | | 16.05 | % | | 15.10 | % | | 16.35 | % | | N/A |
| | N/A |
|
Tangible common equity to tangible assets (1) | | 9.58 | % | | 7.93 | % | | 8.44 | % | | 8.73 | % | | 8.97 | % |
Capital Ratios (Bank) (5) | | | | | | | | | | |
Stockholders' equity to assets | | 11.96 | % | | 10.81 | % | | 11.79 | % | | 12.38 | % | | 12.22 | % |
Tier 1 leverage ratio | | 12.54 | % | | 11.16 | % | | 12.20 | % | | 12.33 | % | | 12.15 | % |
Tier 1 risk-based capital ratio | | 19.90 | % | | 20.43 | % | | 22.68 | % | | 23.12 | % | | 21.28 | % |
Total risk-based capital ratio | | 20.84 | % | | 21.68 | % | | 23.94 | % | | 24.39 | % | | 22.55 | % |
Common Equity Tier 1 ratio | | 19.90 | % | | 20.43 | % | | 22.68 | % | | N/A |
| | N/A |
|
(1) Considered a non-GAAP financial measure. See Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations - ‘‘Non-GAAP Financial Measures’’ for a reconciliation of our non-GAAP measures to the most directly comparable GAAP financial measure. Pre-tax, pre-provision net earnings is defined as net income plus income tax expense (benefit) and provision for (reversal of) loan losses. Net tangible book value is defined as total assets less goodwill and total liabilities. Efficiency ratio is defined as the ratio of noninterest expense to net interest income plus noninterest income. We calculate our pro forma net income, return on average assets and return on average equity by adding back our franchise S Corporation tax to net income, and using a combined C Corporation effective tax rate for federal and California income taxes of 42.0%. This calculation reflects only the change in our status as an S Corporation and does not give effect to any other transaction. |
(2) Earnings per common share, basic and diluted, book value per common share and number of common shares outstanding have been adjusted retroactively to reflect a 200-for-1 stock split effective April 27, 2017. |
(3) Loans held-for-investment include unamortized deferred fees/costs. All portfolio loans are collateralized by real estate with the exception of one $50 thousand non-mortgage loan. |
(4) As a result of system conversions, we are unable to calculate daily average balances for 2014 and 2013. For these periods, average loans, assets and equity are calculated by averaging the ending balance of the prior month and the ending balance of the current month and multiplying the average by the number of days in the current month. The twelve resulting products were then added together and the resulting sum is divided by the number of days in the year. |
(5) Capital ratios as of December 31, 2017, 2016 and 2015 reflect the adoption of Basel III, effective January 1, 2015, while ratios in prior years represent the previous capital rules. |
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is based on and should be read in conjunction with Part II. Item 6. "SelectedSelected Financial Data"Data and our consolidated financial statements and the accompanying notes thereto contained elsewhere in this Annual Report on Form 10-K. However, becauseReport. Because we conduct all of our material business operations through our bank subsidiary, Luther Burbank Savings, the discussion and analysis relates to activities primarily conducted by the Bank.
The following discussion and analysis is intended to facilitate the understanding and assessment of significant changes and trends in our businessesbusiness that accounted for the changes in our results of operations infor the year ended December 31, 2017, as compared to our results of operation in the year ended December 31, 2016; in our results of operations in the year ended December 31, 2016,2022, as compared to our results of operations infor the year ended December 31, 2015,2021, and our financial condition at December 31, 20172022 as compared to our financial condition at December 31, 2016.
2021.
In addition to historical information, this discussion and analysis contains forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that we believe are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth in the “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors” sections of this Annual Report, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. Please read these sections carefully. We assume no obligation to update any of these forward-looking statements.
Overview
We are a bank holding company headquartered in Santa Rosa, California, and the parent company of Luther Burbank Savings, a California-chartered commercial bank headquartered in Manhattan Beach, California with $5.7$8.0 billion in assets at December 31, 2017.2022. Our
principal business is providing high-value, relationship-based banking products and services to our customers, which include real estate investors, professionals, entrepreneurs, high net worth individualsdepositors and commercial businesses. We generate most of our revenue from interest on loans and investments. Our primary source of funding for our loans is retail deposits and we place secondary reliance on wholesale funding, primarily borrowings from the FHLB.FHLB and brokered deposits. Our largest expenses are interest on deposits and borrowings along with salaries and related employee benefits. Our principal lending products are real estate secured loans, consisting primarily on smaller, existingof multifamily residential properties with stabilized rent rolls, and catering predominantly to low and middle income renters who are unable to afford to purchase a single family residence or condominium unit in the high demand, low supply residential markets of the West Coast, and purchase money mortgages on higher endjumbo single family residential properties.
properties on the West Coast.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles generally accepted in the United States(“GAAP”) and with general practices within the financial services industry. Application of these principles requires management to make complex and subjective estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances. These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates. Actual results may differ from these estimates.
Our most significant accounting policies are described in Note 1 to our Financial Statements for the year ended December 31, 2017.2022. We have identified the following accounting policies and estimates that, due to the difficult, subjective or complex judgments and assumptions inherent in those policies and estimates and the potential sensitivity of our financial statements to those judgments and assumptions, are critical to an understanding of our financial condition and results of operations. We believe that the judgments, estimates and assumptions used in the preparation of our financial statements are reasonable and appropriate.
Pursuant to 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 such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we may adopt the standard for the private company.
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 Loan Losses
The allowance for loan losses is provided for probable incurred credit losses inherent in the loan portfolio at the balance sheetstatement of financial condition date. The allowance is increased by a provision charged to expense and can be reduced by loan principal charge-offs, net of recoveries. WhereThe allowance can also be reduced by recapturing provisions when management determines that the allowance for loan losses is more than adequate to absorb the probable incurred credit losses in the portfolio, the allowance is reduced by recapturing provisions and a credit is made to the expense account.portfolio. The allowance is based on management’s assessment of various factors including, but not limited to, the nature of the loan portfolio, previous loss experience, known and inherent risks in the portfolio, the estimated value of underlying collateral, information that may affect a borrower’s ability to repay, current economic conditions and the results of our ongoing reviews of the portfolio.
In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management.
While we use available information, including independent appraisals for collateral, to estimate the extent of probable incurred loan losses within the loan portfolio, inherent uncertainties in the estimation process make it reasonably possible that ultimate losses may vary significantly from our original estimates. In addition, we utilize a number of economic variables in estimating the allowance, with the most significant drivers being unemployment levels and housing prices. Material changes in these economic variables may result in incremental changes in the estimated level of our allowance. Generally, loans are partially or fully charged off when it is determined that the unpaid principal balance exceeds the current fair value of the collateral with no other likely source of repayment.
Loans Held The Company utilized the incurred loss methodology to determine its allowance for Sale
Loans originated and intended for sale inloan losses at December 31, 2022. The Company adopted the secondary market are carried at fair value. Loans originated and intended for sale only afterCECL allowance methodology on January 1, 2023. The impact of the adoption of CECL is still being evaluated but is not expected to have a minimum 12 month periodmaterial impact on our financial condition or results of seasoning, a practice generally utilized to allow for appropriate community reinvestment lending recognition, are classified as held for sale and are carried at the lower of aggregate cost or fair value. Loans transferred to the held-for-sale portfolio that were not originated with the intent to sell are carried at the lower of aggregate cost or fair value. Changes in the fair value of loans that are carried at fair value are recorded in noninterest income in the period incurred.
When determining whether to recognize sale accounting, we give consideration to the legal isolation of transferred assets including the right to pledge or exchange such assets and the surrender of control over transferred assets. Loan sale transactions that involve securitizations with variable interest entities are evaluated for consolidation with consideration given to the nature and extent of continuing involvement with the transferred assets. When the conditions for sale accounting and legal isolation are met, loans are derecognized from the balance sheet and any gains or losses are recorded to earnings through noninterest income.
operations.
Fair Value Measurement
We use estimates of fair value in applying various accounting standards for our consolidated financial statements. Fair value is defined as the exit price at which an asset may be sold or a liability may be transferred in an orderly transaction between willing and able market participants. When available, fair value is measured by looking at observable market prices for identical assets and liabilities in an active market. When these are not available, other inputs are used to model fair value such as prices of similar instruments, yield curves, prepayment speeds and credit spreads. Methods used to estimate fair value do not necessarily represent an exit price. Depending on the availability of observable inputs and prices, different valuation models could
produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.
Changes in the fair value of investments available-for-sale and derivatives designated as effective cash flow hedgesdebt securities available for sale are recorded in our consolidated balance sheetstatements of financial condition and other comprehensive income (loss) while changes in the fair value of equity securities, loans held for sale or otherand derivatives are recorded in the consolidated balance sheetstatements of financial condition and in the statementconsolidated statements of operations.
income.
Investment Securities Impairment
We assess on a quarterly basis whether there have been any events or economic circumstances to indicate that a security in which we have an unrealized loss is impaired on an other-than-temporary basis. In any instance, we would consider many factors, including the severity and duration of the impairment, the portion of any unrealized loss attributable to a decline in the credit quality of the issuer, our intent and ability to hold the security for a period of time sufficient for a recovery in value, recent events specific to the issuer or industry, and, for debt securities, external credit ratings and recent downgrades. Securities with respect to which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value.
Non-GAAP Financial Measures
Some of the financial measures discussed in Item 6 -6. Selected Financial Data are ‘‘non-GAAPand Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations contain 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,measures that are included or excluded, as the case may be, in the most directly comparable measure calculatednot measures recognized under GAAP and presented in accordance with generally accepted accounting principles as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows.
Pre-tax,therefore, are considered non‐GAAP financial measures, including pre-tax, pre-provision net earnings, is defined as income before taxes and provision for loan losses. We believe the most directly comparable GAAP financial measure is income before taxes. Disclosure of this measure enables you to compare our operations to those of other banking companies before consideration of taxes and provision expense, which some investors may consider to be a more appropriate comparison given our S Corporation status and recaptures from the allowance for loan losses. We calculate our pro forma net income, return on averageefficiency ratio, tangible assets, return on averagetangible stockholders' equity and per share amounts by adding back our franchise S Corporation tax to net income, and using a combined C Corporation effective tax rate for federal and California income taxes of 42.0%. This calculation reflects only the change in our status as an S Corporation and does not give effect to any other transaction.Net tangible book value is defined as total assets less goodwillper share.
Our management uses these non‐GAAP financial measures in their analysis of the Company’s performance, financial condition and total liabilities. Efficiency ratio is defined as noninterest expenses divided by operating revenue, which is equal to net interest income plus noninterest income. the efficiency of its operations. We believe that these non-GAAPnon‐GAAP financial measures provide useful information to management and investors that is supplementary to our financial condition, resultsa greater understanding of ongoing operations and cash flows computedenhance comparability of results with prior periods and other companies, as well as demonstrate the effects of significant changes in accordance with GAAP.the current period. We also believe that investors find these non‐GAAP financial measures useful as they assist investors in understanding our underlying operating performance and the analysis of ongoing operating trends. However, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, youYou 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 their non-GAAP financial measures when making comparisons.
The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:
|
| | | | | | | | | | | | | | | | | | | | |
| | For the years ended December 31, |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
Pre-tax, pre-provision net earnings | | | | | | | | | | |
Net income before income taxes | | $ | 65,231 |
| | $ | 53,940 |
| | $ | 36,639 |
| | $ | 35,721 |
| | $ | 54,173 |
|
Plus: Provision (reversal of) for loan losses | | (3,372 | ) | | (12,703 | ) | | (7,141 | ) | | — |
| | 7,500 |
|
Pre-tax, pre-provision net earnings | | $ | 61,859 |
| | $ | 41,237 |
| | $ | 29,498 |
| | $ | 35,721 |
| | $ | 61,673 |
|
| | | | | | | | | | |
Tangible book value | | | | | | | | | | |
Total assets | | $ | 5,704,380 |
| | $ | 5,063,585 |
| | $ | 4,361,779 |
| | $ | 3,969,047 |
| | $ | 3,659,069 |
|
Less: Goodwill | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) |
Less: Total liabilities | | (5,154,635 | ) | | (4,659,210 | ) | | (3,990,480 | ) | | (3,619,539 | ) | | (3,327,672 | ) |
Tangible book value | | $ | 546,448 |
| | $ | 401,078 |
| | $ | 368,002 |
| | $ | 346,211 |
| | $ | 328,100 |
|
| | | | | | | | | | |
Pro forma provision for income tax | | | | | | | | | | |
Net income before income taxes | | $ | 65,231 |
| | $ | 53,940 |
| | $ | 36,639 |
| | $ | 35,721 |
| | $ | 54,173 |
|
Total effective pro forma tax rate | | 42 | % | | 42 | % | | 42 | % | | 42 | % | | 42 | % |
Pro forma provision for income taxes | | $ | 27,397 |
| | $ | 22,655 |
| | $ | 15,388 |
| | $ | 15,003 |
| | $ | 22,753 |
|
| | | | | | | | | | |
Pro forma net income | | | | | | | | | | |
|
| | | | | | | | | | | | | | | | | | | | |
Net income before income taxes | | $ | 65,231 |
| | $ | 53,940 |
| | $ | 36,639 |
| | $ | 35,721 |
| | $ | 54,173 |
|
Pro forma provision for income taxes | | 27,397 |
| | 22,655 |
| | 15,388 |
| | 15,003 |
| | 22,753 |
|
Pro forma net income | | $ | 37,834 |
| | $ | 31,285 |
| | $ | 21,251 |
| | $ | 20,718 |
| | $ | 31,420 |
|
| | | | | | | | | | |
Pro forma ratios and per share data | | | | | | | | | | |
Pro forma net income (numerator) | | $ | 37,834 |
| | $ | 31,285 |
| | $ | 21,251 |
| | $ | 20,718 |
| | $ | 31,420 |
|
| | | | | | | | | | |
Average assets (denominator) | | 5,485,832 |
| | 4,676,676 |
| | 4,040,381 |
| | 3,796,650 |
| | 3,628,878 |
|
Pro forma return on average assets | | 0.69 | % | | 0.67 | % | | 0.53 | % | | 0.55 | % | | 0.87 | % |
| | | | | | | | | | |
Average stockholders' equity (denominator) | | 425,698 |
| | 390,318 |
| | 359,359 |
| | 343,412 |
| | 326,677 |
|
Pro forma return on average stockholders' equity | | 8.89 | % | | 8.02 | % | | 5.91 | % | | 6.03 | % | | 9.62 | % |
| | | | | | | | | | |
Weighted average shares outstanding - basic (denominator) | | 42,916,879 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
|
Pro forma net income per common share—basic | | $ | 0.88 |
| | $ | 0.74 |
| | $ | 0.51 |
| | $ | 0.49 |
| | $ | 0.75 |
|
| | | | | | | | | | |
Weighted average shares outstanding - diluted (denominator) | | 42,957,936 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
| | 42,000,000 |
|
Pro forma net income per common share—diluted | | $ | 0.88 |
| | $ | 0.74 |
| | $ | 0.51 |
| | $ | 0.49 |
| | $ | 0.75 |
|
| | | | | | | | | | |
Efficiency ratio | | | | | | | | | | |
Noninterest expense (numerator) | | $ | 56,544 |
| | $ | 61,242 |
| | $ | 62,339 |
| | $ | 61,886 |
| | $ | 43,953 |
|
Net interest income | | $ | 110,945 |
| | $ | 94,635 |
| | $ | 84,913 |
| | $ | 93,999 |
| | $ | 103,810 |
|
Noninterest income | | 7,458 |
| | 7,844 |
| | 6,924 |
| | 3,608 |
| | 1,816 |
|
Operating revenue (denominator) | | $ | 118,403 |
| | $ | 102,479 |
| | $ | 91,837 |
| | $ | 97,607 |
| | $ | 105,626 |
|
Efficiency ratio | | 47.76 | % | | 59.76 | % | | 67.88 | % | | 63.40 | % | | 41.61 | % |
| | | | | | | | | | |
Tangible assets | | | | | | | | | | |
Total assets | | $ | 5,704,380 |
| | $ | 5,063,585 |
| | $ | 4,361,779 |
| | $ | 3,969,047 |
| | $ | 3,659,069 |
|
Less: Goodwill | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) |
Tangible assets | | $ | 5,701,083 |
| | $ | 5,060,288 |
| | $ | 4,358,482 |
| | $ | 3,965,750 |
| | $ | 3,655,772 |
|
| | | | | | | | | | |
Tangible stockholders' equity | | | | | | | | | | |
Total stockholders' equity | | $ | 549,745 |
| | $ | 404,375 |
| | $ | 371,299 |
| | $ | 349,508 |
| | $ | 331,397 |
|
Less: Goodwill | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) | | (3,297 | ) |
Tangible stockholders' equity | | $ | 546,448 |
| | $ | 401,078 |
| | $ | 368,002 |
| | $ | 346,211 |
| | $ | 328,100 |
|
| | | | | | | | | | |
Tangible common equity to tangible assets | | | | | | | | | | |
Tangible stockholders' equity (numerator) | | $ | 546,448 |
| | $ | 401,078 |
| | $ | 368,002 |
| | $ | 346,211 |
| | $ | 328,100 |
|
Tangible assets (denominator) | | $ | 5,701,083 |
| | $ | 5,060,288 |
| | $ | 4,358,482 |
| | $ | 3,965,750 |
| | $ | 3,655,772 |
|
Tangible common equity to tangible assets | | 9.58 | % | | 7.93 | % | | 8.44 | % | | 8.73 | % | | 8.97 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands, except per share data) | | As of or For the Years Ended December 31, |
| 2022 | | 2021 | | 2020 | | 2019 | | 2018 |
Pre-tax, Pre-provision Net Earnings |
Income before provision for income taxes | | $ | 113,737 | | | $ | 124,000 | | | $ | 56,659 | | | $ | 69,464 | | | $ | 62,931 | |
Plus: Provision for (reversal of) loan losses | | 1,150 | | | (10,800) | | | 10,550 | | | 1,250 | | | 3,600 | |
Pre-tax, pre-provision net earnings | | $ | 114,887 | | | $ | 113,200 | | | $ | 67,209 | | | $ | 70,714 | | | $ | 66,531 | |
Efficiency Ratio |
Noninterest expense (numerator) | | $ | 64,027 | | | $ | 59,145 | | | $ | 73,934 | | | $ | 62,368 | | | $ | 62,687 | |
Net interest income | | 177,254 | | | 170,459 | | | 138,623 | | | 128,407 | | | 125,087 | |
Noninterest income | | 1,660 | | | 1,886 | | | 2,520 | | | 4,675 | | | 4,131 | |
Operating revenue (denominator) | | $ | 178,914 | | | $ | 172,345 | | | $ | 141,143 | | | $ | 133,082 | | | $ | 129,218 | |
Efficiency ratio | | 35.79 | % | | 34.32 | % | | 52.38 | % | | 46.86 | % | | 48.51 | % |
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Tangible Book Value Per Share |
Total assets | | $ | 7,974,632 | | | $ | 7,179,957 | | | $ | 6,906,104 | | | $ | 7,045,828 | | | $ | 6,937,212 | |
Less: Goodwill | | (3,297) | | | (3,297) | | | (3,297) | | | (3,297) | | | (3,297) | |
Tangible assets | | 7,971,335 | | | 7,176,660 | | | 6,902,807 | | | 7,042,531 | | | 6,933,915 | |
Less: Total liabilities | | (7,292,096) | | | (6,510,824) | | | (6,292,413) | | | (6,431,364) | | | (6,356,067) | |
Tangible stockholders' equity (numerator) | | $ | 679,239 | | | $ | 665,836 | | | $ | 610,394 | | | $ | 611,167 | | | $ | 577,848 | |
Period end shares outstanding (denominator) | | 51,073,272 | | | 51,682,398 | | | 52,220,266 | | | 55,999,754 | | | 56,379,066 | |
Tangible book value per share | | $ | 13.30 | | | $ | 12.88 | | | $ | 11.69 | | | $ | 10.91 | | | $ | 10.25 | |
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Key Factors Affecting Our Business
Interest Rates
Net interest income is the largest 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 wholesale 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.
We anticipate that interest rates will continue to increase over the historic lows experienced over the past several years. Based on our liability sensitivity as discussed in Item 7A. ‘‘Quantitative and Qualitative Disclosures About Market Risk’’, significant increases in interest rates, the yield curvepace of interest rate increases, and/or a flatter yield curve could have an adverse impact on our net interest income. Conversely, decreases in interest rates, particularly at the short end, and/or a steepened yield curve would be expected to benefit our net interest income.
Operating Efficiency
Since 2013, weWe have invested significantly in our infrastructure, including our management, lending teams, technology systems and risk management practices. As a result, our ratio of general and administrative expenses to income increased over our levels in earlier years. As we have begun to leverage these investments, our efficiency has generally improved. We believe that we are well positioned for future growth without needing additional significant investment and therefore expect thatHowever, due to the current rising interest rate environment, which has generally had a greater impact on our cost of funds as compared to the yield on interest-earnings assets, our efficiency ratio may become a less relevant measure of our expense management. As an alternative, we believe that the comparison of our noninterest expense to total average assets will continue to improve.
provide a better measure of our efficiency and expense management in this rate environment.
Credit Quality
We have well established loan policies and underwriting practices that have generally resulted in very low levels of charge-offs and nonperforming assets. We strive to originate quality loans that will maintain the credit quality of our
loan portfolio. However, credit trends in the markets in which we operate are largely impacted by economic conditions beyond our control and can adversely impact our financial condition.
condition and results of operations.
Competition
The industry and businesses in which we operate are highly competitive. We may see increased competition in different areas including interest rates, underwriting standards and product offerings and loan structure. While we seek to maintain an appropriate return on our investments, we anticipate that we willmay experience continued pressure on our net interest marginsmargin as we operate in this competitive environment.
Economic Conditions
Our business and financial performance are affected by economic conditions generally in the United States and more directly in the markets of California, Washington and Oregon where we primarily operate. The significant economic factors that are most relevant to our business and our financial performance include, but are not limited to, real estate values, interest rates and unemployment rates.
Factors Affecting Comparability of Financial Results
S Corporation Status
We terminated our status as a “Subchapter S” corporation as of December 1, 2017, in connection with our IPO. Prior to this date, we elected to be taxed for U.S. federal income tax purposes as an S Corporation. As a result, our earnings were not subject to, and we did not 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 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 rate of 3.5%.
Upon the termination of our status as an S Corporation on December 1, 2017, we commenced paying U.S. federal income tax and a higher California income tax on our taxable earnings and our financial statements will reflect a provision for both U.S. federal income tax and California income tax. As a result of this change, the net income and earnings per share data presented in our historical financial statements and the other financial information set forth in this Annual Report, which unless otherwise specified, do not include any provision for U.S. federal income tax, will not be comparable with our future net income and earnings per share 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 California income tax rate, currently at 10.84%.
The termination of our status as an S Corporation may also affect our financial condition and cash flows. Historically, we have 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 income tax liabilities resulting from our taxable income that was ‘‘passed through’’ to them. However, these distributions have not been consistent, as sometimes the distributions have been less than or in excess of the shareholder’s estimated U.S. federal and California income tax liabilities resulting from their ownership of our stock. In addition, these estimates have been based on individual income tax rates, which may differ from the rates imposed on the income of C Corporations. Subsequent to the termination of our S Corporation status on December 1, 2017, other than our obligations under the tax sharing agreement with prior S Corporation shareholders as set forth in the "Risk Factors" section of this Annual Report, no income will be ‘‘passed through’’ to any shareholders, but, as noted above, we have commenced paying U.S. federal income tax and a higher California income tax. The amounts that we have historically distributed to our shareholders may not be indicative of the amount of U.S. federal and California income tax that we will be required to pay after December 1, 2017. 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.
Deferred tax assets and liabilities will be 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. A $5.3 million tax benefit was recognized during the fourth quarter of 2017 from the restatement of the Company's net deferred tax assets related to the revocation of its S Corporation status and the recently enacted Tax Cuts and Jobs Act.
Retail Mortgage Banking Activity and Other Loan Sales
We began retail mortgage banking operations in 2013, with the primary purpose of serving a wider customer base of consumers who desire 30-year fixed rate single family real estate financing. We offered a wide range of mortgage products including variable rate 3, 5, 7 and 10-year hybrid products and long-term fixed rate programs. While much of the variable rate loan production from this activity was held in our loan portfolio, the long-term fixed loan originations were sold to correspondents or to Freddie Mac. Since 2016, we have sold $31.3 million of single family residential loans to Freddie Mac, on a servicing retained basis. We also brokered loans to other financial institutions where those organizations had a desirable product for our customers. As part of our retail mortgage banking activity, we also made single family residential construction loans, $37.3 million of which remained on our books, and $11.0 million of which were subject to commitments for future disbursements, at December 31, 2017.
In December 2016, we decided to wind down this business activity during the first quarter of 2017, as we found that the highly competitive nature and expense of running this business was unprofitable, primarily due to the lack of sufficient loan volume needed to offset fixed costs. Revenue from this activity, including net gains on the sales of loans, broker fee income and servicing fee income can be found in noninterest income on our consolidated statements of operations while the related expenses are captured in noninterest expense on the consolidated statements of operations.
While we are still able to originate single family residential loans on a retail basis with our portfolio of hybrid products, we are not actively pursuing this business. Our single family residential loans are primarily sourced from brokers, with many of which we have long-term relationships. This activity has been a significant part of our lending business since 2006.
Multifamily Securitization Transaction
During 2017, we entered into a trust sale memorandum of understanding with Freddie Mac, pursuant to which we agreed to sell a portfolio of multifamily loans to a real estate mortgage investment conduit, or REMIC, that holds the loans in trust and issued securities that are fully guaranteed by Freddie Mac and privately offered and sold to investors. On September 27, 2017, we closed this securitization transaction. We did not purchase any of the securities for our portfolio.
The primary purpose of this multifamily securitization transaction was to enable us to redeploy capital and funding to support higher-yielding assets while also reducing our reliance on wholesale funding, improving liquidity measures and reducing our concentration of multifamily loans.
The size of the multifamily loan portfolio sold to the REMIC was $626.1 million, consisting of one class of post-reset, variable rate 3, 5, and 7-year hybrid loans in an aggregate principal amount of approximately$91.6 million, and two classes of pre-reset, variable rate 3, 5 and 7-year hybrid loans in an aggregate principal amount of approximately $534.5 million. 74.3% of the loan portfolio consisted of loans for multifamily properties located in California, while the remaining 25.7% of the loan portfolio consistent of loans for multifamily properties located in Washington. We retain sub-servicing obligations on the loan portfolio. The gross proceeds of this sale to us was approximately $637.6 million. We used the proceeds of this sale to pay down short-term FHLB borrowings. These borrowings had no prepayment penalties associated with them. The following table summarizes the loans that sold in this securitization.
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Loan Type | Number of Mortgage Loans | Principal Balance (1)(2) | Percentage of Mortgage Pool Balance | Weighted Average Mortgage Rate (2) | Loan to Value Ratio (2) | Debt Service Coverage Ratio (2) |
Post-Reset Hybrid Loans | 65 |
| $ | 91,552 |
| 14.6 | % | 3.66 | % | 53.2 | % | 1.88 |
|
Pre-Reset Hybrid Loans (3) | 237 |
| 415,628 |
| 66.4 |
| 3.39 |
| 54.2 |
| 1.67 |
|
Pre-Reset Hybrid Loans (4) | 70 |
| 118,880 |
| 19.0 |
| 3.51 |
| 46.5 |
| 1.70 |
|
Total | 372 |
| $ | 626,060 |
| 100.0 | % | 3.45 | % | 52.6 | % | 1.71 |
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(2) | Represents balance, weighted average rate and ratios at the security cut-off date of September 1, 2017. |
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(3) | Loans have 1 to 40 months until their first rate reset. |
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(4) | Loans have 41 or more months until their first rate reset. |
In connection with the securitization, we entered into a reimbursement agreement with Freddie Mac, pursuant to which we are obligated to reimburse Freddie Mac for the first losses in the underlying loan portfolio not to exceed 10% of the unpaid principal amount of the loans comprising the securitization pool at settlement, or approximately $62.6 million. Our reimbursement obligation is supported by a FHLB letter of credit. Our reimbursement obligation will terminate on the later of (i) the date on which Freddie Mac has no further liability (accrued or contingent) under its guarantee for these securities or (ii) the date on which the we shall pay to Freddie Mac our full reimbursement obligation.
As a result of our exit from retail mortgage banking and current securitization activities, gains on the sale of loans and other fee income shown as noninterest income in our consolidated statements of operations may not be directly comparable, and will likely vary, from period to period.
Public Company Costs
As a result of our recent initial public offering, we expect to incur additional costs associated with operating as a public company. We expect that these costs will include additional personnel, legal, consulting, regulatory, insurance, accounting, investor relations and other expenses that we did not incur as a private company.
The Sarbanes-Oxley Act, as well as rules adopted by the SEC and national securities exchanges, requires public companies to implement specified corporate governance practices that were inapplicable to us as a private company. These additional rules and regulations will increase our legal, regulatory and financial compliance costs and will make some activities more time-consuming and costly.
Results of operationsOperations - Years ended December 31, 20172022 and December 31, 2016
2021
Overview
For the year ended December 31, 20172022 our net income was $69.4$80.2 million as compared to $52.1$87.8 million for the year ended December 31, 2016.2021. The increasedecrease of $17.3$7.6 million, or 33.1%8.6%, was attributed primarily attributable to a $12.0 million increase in the provision for loan losses and a $4.9 million increase in noninterest expense, partially offset by an increase of $16.3$6.8 million in net interest income a $4.7 million reduction in noninterest expense and a $6.0decrease of $2.7 million reduction ofin the provision for income taxes offset by a $9.3 million decrease in the net reversal of provision for loan losses, as compared to the year ended December 31, 2016. The increase in net interest income was credited to strong organic loan growth. The reversal of loan loss provisions were primarily attributable to improved credit metrics within the loan portfolio.prior year. Pre-tax, pre-provision net earnings increased by $20.6$1.7 million, or 50.0%1.5%, for the year ended December 31, 20172022 as compared to the year ended December 31, 2016 largely due to the additional $16.3 million in net interest income.
prior year.
Net Interest Income
Net interest income increased by $16.3 million, or 17.2%, to $110.9totaled $177.3 million for the year ended December 31, 2017 from $94.62022, an increase of $6.8 million, for 2016. Our netcompared to the prior year primarily due to higher interest income on loans, partially offset by higher interest expense on our deposit portfolio.
Net interest margin of 2.05% for the year ended December 31, 20172022 was 2.39%, compared to 2.40% for the prior year. Our net interest margin reflects the net impact of an increase in the cost of interest bearing liabilities, partially offset by an increase in the yield on interest earning assets. Due to the liability sensitivity of our balance sheet, our interest-bearing liabilities generally reprice more quickly than our interest-earning assets. Over the year, cost of our interest-bearing liabilities increased slightly fromby 36 basis points primarily due to an increase in the cost of our deposits, while the yield on our interest-earning assets increased by 32 basis points primarily due to an increase in our loan yield. Our net margin of 2.04%interest spread for the year ended December 31, 2016, primarily due2022 was 2.26%, decreasing by 4 basis points as compared to the rate on new loan origination volume exceeding the rate on loans paid off and sold.last year.
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 and rates paid for the years ended December 31, 20172022, 2021 and 2016.2020. The average balances are daily averagesaverages.
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| For the Years Ended December 31, |
| 2022 | | 2021 | | 2020 |
(Dollars in thousands) | Average Balance | | Interest Inc/Exp | | Yield/Rate | | Average Balance | | Interest Inc/Exp | | Yield/Rate | | Average Balance | | Interest Inc/Exp | | Yield/Rate |
Interest-Earning Assets | | | | | | | | | | | | | | | | | |
Multifamily residential | $ | 4,375,648 | | | $ | 165,988 | | | 3.79 | % | | $ | 4,199,639 | | | $ | 155,509 | | | 3.70 | % | | $ | 4,063,607 | | | $ | 155,104 | | | 3.82 | % |
Single family residential | 2,040,239 | | | 67,852 | | | 3.33 | % | | 1,897,575 | | | 53,695 | | | 2.83 | % | | 1,907,940 | | | 65,030 | | | 3.41 | % |
Commercial real estate | 185,908 | | | 8,673 | | | 4.67 | % | | 196,456 | | | 8,893 | | | 4.53 | % | | 206,639 | | | 9,530 | | | 4.61 | % |
Construction and land | 21,620 | | | 1,292 | | | 5.98 | % | | 18,920 | | | 1,148 | | | 6.07 | % | | 20,199 | | | 1,332 | | | 6.59 | % |
Total loans (1) | 6,623,415 | | | 243,805 | | | 3.68 | % | | 6,312,590 | | | 219,245 | | | 3.47 | % | | 6,198,385 | | | 230,996 | | | 3.73 | % |
Investment securities | 654,794 | | | 14,372 | | | 2.19 | % | | 653,479 | | | 8,451 | | | 1.29 | % | | 647,174 | | | 9,856 | | | 1.52 | % |
Cash and cash equivalents | 142,802 | | | 2,776 | | | 1.94 | % | | 150,166 | | | 223 | | | 0.15 | % | | 185,246 | | | 538 | | | 0.29 | % |
Total interest-earning assets | 7,421,011 | | | 260,953 | | | 3.52 | % | | 7,116,235 | | | 227,919 | | | 3.20 | % | | 7,030,805 | | | 241,390 | | | 3.43 | % |
Noninterest-earning assets (2) | 121,586 | | | | | | | 66,937 | | | | | | | 61,602 | | | | | |
Total assets | $ | 7,542,597 | | | | | | | $ | 7,183,172 | | | | | | | $ | 7,092,407 | | | | | |
Interest-Bearing Liabilities | | | | | | | | | | | | | | | | | |
Transaction accounts | $ | 171,077 | | | 431 | | | 0.25 | % | | $ | 158,956 | | | 358 | | | 0.22 | % | | $ | 178,655 | | | 876 | | | 0.48 | % |
Money market demand accounts | 2,910,026 | | | 26,873 | | | 0.91 | % | | 2,427,599 | | | 11,889 | | | 0.48 | % | | 1,652,109 | | | 14,862 | | | 0.88 | % |
Time deposits | 2,432,642 | | | 29,179 | | | 1.19 | % | | 2,750,461 | | | 23,365 | | | 0.84 | % | | 3,390,992 | | | 57,593 | | | 1.67 | % |
Total deposits | 5,513,745 | | | 56,483 | | | 1.02 | % | | 5,337,016 | | | 35,612 | | | 0.66 | % | | 5,221,756 | | | 73,331 | | | 1.38 | % |
FHLB advances | 957,695 | | | 18,904 | | | 1.97 | % | | 868,591 | | | 14,535 | | | 1.67 | % | | 965,490 | | | 21,761 | | | 2.25 | % |
Junior subordinated debentures | 61,857 | | | 2,015 | | | 3.26 | % | | 61,857 | | | 1,015 | | | 1.64 | % | | 61,857 | | | 1,373 | | | 2.22 | % |
Senior debt | 94,719 | | | 6,297 | | | 6.65 | % | | 94,596 | | | 6,298 | | | 6.66 | % | | 94,473 | | | 6,302 | | | 6.67 | % |
Total interest-bearing liabilities | 6,628,016 | | | 83,699 | | | 1.26 | % | | 6,362,060 | | | 57,460 | | | 0.90 | % | | 6,343,576 | | | 102,767 | | | 1.60 | % |
Noninterest-bearing deposit accounts | 149,443 | | | | | | | 112,436 | | | | | | | 69,208 | | | | | |
Noninterest-bearing liabilities | 87,547 | | | | | | | 65,184 | | | | | | | 68,853 | | | | | |
Total liabilities | 6,865,006 | | | | | | | 6,539,680 | | | | | | | 6,481,637 | | | | | |
Total stockholders' equity | 677,591 | | | | | | | 643,492 | | | | | | | 610,770 | | | | | |
Total liabilities and stockholders' equity | $ | 7,542,597 | | | | | | | $ | 7,183,172 | | | | | | | $ | 7,092,407 | | | | | |
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Net interest spread (3) | | | | | 2.26 | % | | | | | | 2.30 | % | | | | | | 1.83 | % |
Net interest income/margin (4) | | | $ | 177,254 | | | 2.39 | % | | | | $ | 170,459 | | | 2.40 | % | | | | $ | 138,623 | | | 1.97 | % |
(1) Non-accrual loans are included in total loan balances. No adjustment has been made for these loans in the calculation of yields. Interest income on loans includes amortization of deferred loan costs, net of deferred loan fees. Net deferred loan cost amortization totaled $12.6 million, $19.6 million and include both performing$16.2 million for the years ended December 31, 2022, 2021 and nonperforming loans.2020, respectively.
(2) Noninterest-earning assets includes the allowance for loan losses.
(3) Net interest spread is the average yield on total interest-earning assets minus the average rate on total interest-bearing liabilities.
(4) Net interest margin is net interest income divided by total average interest-earning assets. |
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| | | For the Years Ended December 31, |
| | | 2017 | | 2016 |
(Dollars in thousands) | | | Average Balance | | Interest Inc / Exp | | Average Yield/Rate | | Average Balance | | Interest Inc / Exp | | Average Yield/Rate |
Interest-Earning Assets | | | | | | | | | | | | | |
Multifamily residential | | | $ | 2,897,794 |
| | $ | 101,708 |
| | 3.51 | % | | $ | 2,437,487 |
| | $ | 84,766 |
| | 3.48 | % |
Single family residential | | | 1,828,668 |
| | 59,498 |
| | 3.25 | % | | 1,629,370 |
| | 50,756 |
| | 3.12 | % |
Commercial | | | 78,032 |
| | 3,678 |
| | 4.71 | % | | 49,863 |
| | 2,886 |
| | 5.79 | % |
Construction, land and NM | | | 45,400 |
| | 1,689 |
| | 3.72 | % | | 29,993 |
| | 977 |
| | 3.26 | % |
Total Loans (1) | | | 4,849,894 |
| | 166,573 |
| | 3.43 | % | | 4,146,713 |
| | 139,385 |
| | 3.36 | % |
Securities available-for-sale | | | 472,477 |
| | 6,553 |
| | 1.39 | % | | 402,035 |
| | 4,151 |
| | 1.03 | % |
Securities held-to-maturity (2) | | | 7,172 |
| | 236 |
| | 3.29 | % | | 8,570 |
| | 253 |
| | 2.95 | % |
Cash and cash equivalents | | | 87,780 |
| | 925 |
| | 1.05 | % | | 76,003 |
| | 370 |
| | 0.49 | % |
Total interest-earning assets | | | $ | 5,417,323 |
| | $ | 174,287 |
| | 3.22 | % | | $ | 4,633,321 |
| | $ | 144,159 |
| | 3.11 | % |
Noninterest-earning assets (3) | | | 68,509 |
| | | | | | 43,355 |
| | | | |
Total assets | | | $ | 5,485,832 |
| | | | | | $ | 4,676,676 |
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Interest-Bearing Liabilities | | | | | | | | | | | | | |
Transaction accounts (4) | | | $ | 218,683 |
| | $ | 1,553 |
| | 0.71 | % | | $ | 130,573 |
| | $ | 502 |
| | 0.38 | % |
Money market demand accounts | | | 1,495,794 |
| | 12,099 |
| | 0.81 | % | | 1,440,129 |
| | 10,506 |
| | 0.73 | % |
Time deposits | | | 1,972,747 |
| | 25,161 |
| | 1.28 | % | | 1,629,479 |
| | 20,640 |
| | 1.27 | % |
Total deposits | | | 3,687,224 |
| | 38,813 |
| | 1.05 | % | | 3,200,181 |
| | 31,648 |
| | 0.99 | % |
FHLB advances | | | 1,160,555 |
| | 16,555 |
| | 1.43 | % | | 879,237 |
| | 10,219 |
| | 1.16 | % |
Senior debt | | | 94,090 |
| | 6,309 |
| | 6.71 | % | | 93,956 |
| | 6,309 |
| | 6.71 | % |
Junior subordinated debentures | | | 61,857 |
| | 1,665 |
| | 2.69 | % | | 61,857 |
| | 1,348 |
| | 2.18 | % |
Total interest-bearing liabilities | | | $ | 5,003,726 |
| | $ | 63,342 |
| | 1.27 | % | | $ | 4,235,231 |
| | $ | 49,524 |
| | 1.17 | % |
Noninterest-bearing liabilities | | | 56,408 |
| | | | | | 51,127 |
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Total stockholders' equity | | | 425,698 |
| | | | | | 390,318 |
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Total liabilities and stockholders' equity | | | $ | 5,485,832 |
| | | | | | $ | 4,676,676 |
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Net interest spread (5) | | | | | | | 1.95 | % | | | | | | 1.94 | % |
Net interest income/margin (6) | | | | | $ | 110,945 |
| | 2.05 | % | | | | $ | 94,635 |
| | 2.04 | % |
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(1) | Loan balance includes portfolio real estate loans, real estate loans held for sale and one $50 thousand non-mortgage loan. Non-accrual loans are included in total loan balances. No adjustment has been made for these loans in the calculation of yields. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs. Net deferred loan cost amortization totals $9.3 million and $9.9 million for the years ended December 31, 2017 and December 31, 2016, respectively. |
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(2) | Securities held to maturity include obligations of states and political subdivisions of $285 thousand and $302 thousand as of December 31, 2017 and December 31, 2016, respectively. Yields are not calculated on a tax equivalent basis. |
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(3) | Noninterest earning assets includes the allowance for loan losses. |
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(4) | Transaction accounts include both interest and non-interest bearing deposits. |
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(5) | Net interest spread is the average yield on total interest-earning assets minus the average rate on total interest-bearing liabilities. |
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(6) | Net interest margin is net interest income divided by total interest-earning assets. |
Interest rates and operating interest differential. Increases and decreases in interest income and interest expense result from changechanges in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest 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- bearinginterest-bearing liabilities during the periods indicated. The effect of changes in volume is determined by multiplying the change in volume by the currentprior period’s average rate. The effect of rate changes is calculated by multiplying the change in average rate by the prior period’s volume.
The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the changes in each.
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| For the Years Ended December 31, |
| 2017 vs 2016 |
| Variance Due To |
| | | Yield/ | | |
(Dollars in thousands) | Volume | | Rate | | Total |
Interest-Earning Assets | | | | | |
Multifamily residential | $ | 16,150 |
| | $ | 793 |
| | $ | 16,943 |
|
Single family residential | 6,410 |
| | 2,332 |
| | 8,742 |
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Commercial | 1,402 |
| | (611 | ) | | 791 |
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Construction, land and NM | 558 |
| | 154 |
| | 712 |
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Total Loans | 24,520 |
| | 2,668 |
| | 27,188 |
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Securities available-for-sale | 811 |
| | 1,591 |
| | 2,402 |
|
Securities held-to-maturity | (44 | ) | | 27 |
| | (17 | ) |
Cash and cash equivalents | 65 |
| | 490 |
| | 555 |
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Total interest-earning assets | $ | 25,352 |
| | $ | 4,776 |
| | $ | 30,128 |
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Interest-Bearing Liabilities | | | | | |
Transaction accounts | $ | 466 |
| | $ | 585 |
| | $ | 1,051 |
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Money market demand accounts | 418 |
| | 1,175 |
| | 1,593 |
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Time deposits | 4,377 |
| | 144 |
| | 4,521 |
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Total deposits | 5,261 |
| | 1,904 |
| | 7,165 |
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FHLB advances | 3,704 |
| | 2,632 |
| | 6,336 |
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Senior debt | 9 |
| | (9 | ) | | — |
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Junior subordinated debentures | — |
| | 317 |
| | 317 |
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Total interest-bearing liabilities | $ | 8,974 |
| | $ | 4,844 |
| | $ | 13,818 |
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Net Interest Income | | | | | |
Net Interest Income | $ | 16,378 |
| | $ | (68 | ) | | $ | 16,310 |
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Total interest income increased by $30.1 million, or 20.9% for the year ended December 31, 2017 as compared to the same period of 2016. Interest income from real estate loans accounted for $27.2 million of that amount as the average daily balance of loans increased by $703.2 million, or 17.0%. The interest income increase from greater average loan balances was further enhanced by a seven basis point increase in loan yield. The volume of new loans originated totaled $2.1 billion for both years ended December 31, 2017 and 2016, respectively. The weighted average rate on new loans for calendar 2017 was 4.00% as compared to the weighted average rate on new loans for calendar 2016 of 3.51%. The weighted average rate on loan curtailments/payoffs during 2017 was 3.69% as compared to a weighted average loan curtailment/payoff rate of 3.77% for calendar 2016.
Total interest expense increased $13.8 million to $63.3 million for the year ended December 31, 2017 from $49.5 million for the year ended December 31, 2016. Interest expense on customer deposits increased $7.2 million to $38.8 million for the year ended December 31, 2017 from $31.6 million for the same period of 2016. This increase is due to average daily deposit balances increasing by $487.0 million, or 15.2%, from period to period while the cost of deposits grew to 1.05% for the year ended December 31, 2017, from 0.99% for the same period ended 2016. Interest expense on advances from the FHLB accounted for $6.3 million of that increase as average daily advances increased by $281.3 million, or 32.0%, from period to period while the cost of those advances increased to 1.43% for the year ended December 31, 2017, as compared to 1.16% for the year ended December 31, 2016. We use both customer deposits and FHLB advances to fund net loan growth. We also use FHLB advances, with or without embedded interest rate caps, as a hedge of interest rate risk, as we can strategically control the duration of those funds. A discussion of
instruments used to mitigate interest rate risk can be found under ‘‘Quantitative and Qualitative Disclosures About Market Risk.’’
Provision for Loan Losses
A reversal of prior provisions for loan losses totaled $3.4 million for the year ended December 31, 2017 as compared to a reversal of loan loss provisions of $12.7 million for the year ended December 31, 2016. The level of loss provisions recorded in any period typically corresponds to increase or decrease in the total balance of loans held-for-investment. At times, however, refinements in our model and improvements in the credit metrics of our real estate portfolio, measures such as collateral support, debt service coverage, and payment performance along with continued general economic recovery will cause management to reevaluate quantitative and qualitative adjustments within our methodology for calculating the allowance for loan losses and will result in an expected reduction to the allowance for loan losses. During 2017, continued and prolonged improvements in the credit quality of our loan portfolio necessitated a release of the allowance balance. We have recorded net loan recoveries for the past three fiscal years due in large part to minimal balances of problem loans as well as strong collateral support of our credits attributed to our lower portfolio loan-to-value ratios and a healthy real estate market. While loans in our portfolio occasionally become impaired, the loans, as individually analyzed and measured, generally do not require a charge-off or reserve for loss. While our nonperforming loans as a percentage of total loans increased slightly from 0.06% to 0.14% from December 31, 2016 to December 31, 2017, 52% of those loans, by balance, were current and paying as agreed at December 31, 2017. Additionally, our classified loans as a percentage of total loans decreased 42%, from 0.48% to 0.28%, over the same period.
Noninterest Income
Noninterest income decreased by $386.0 thousand to $7.5 million for the year ended December 31, 2017 from $7.8 million for the year ended December 31, 2016.
The following table presents the major components of our noninterest income for the years ended December 31, 2017 and 2016:
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| | | | | | | | | | | | | | |
| For the Years Ended December 31, |
(Dollars in thousands) | 2017 | | 2016 | | $ Increase (Decrease) | | % Increase (Decrease) |
Noninterest Income | | | | | | | |
FHLB stock dividends | $ | 2,473 |
| | $ | 2,848 |
| | $ | (375 | ) | | (13.2 | )% |
Fee income | 1,377 |
| | 834 |
| | 543 |
| | 65.1 | % |
Gain on sale of loans | 3,277 |
| | 3,884 |
| | (607 | ) | | (15.6 | )% |
Earnings on CSV life insurance | 192 |
| | 233 |
| | (41 | ) | | (17.6 | )% |
Other | 139 |
| | 45 |
| | 94 |
| | 208.9 | % |
Total noninterest income | $ | 7,458 |
| | $ | 7,844 |
| | $ | (386 | ) | | (4.9 | )% |
FHLB stock dividends. As a member of the FHLB of San Francisco, we are required to own an amount of FHLB stock based on our level of borrowings and other factors. FHLB stock dividends decreased by $375 thousand to $2.5 million for the year ended December 31, 2017 from a level of $2.8 million for the same period ended December 31, 2016. Although our daily average FHLB stock holdings were greater in 2017 as compared to 2016, the FHLB declared and paid an extra, or “special”, dividend during 2016 of $917 thousand whereas no “special” dividends were distributed during 2017 causing a decrease in dividend income.
Fee Income. Fee income consists primarily of loan servicing fee income, fees related to customer deposits, fees from expired loan commitments and broker fee income from mortgage banking operations. Fee income increased by $543 thousand to $1.4 million for the year ended December 31, 2017 from a level of $834 thousand for the same period ended December 31, 2016. The increase was primarily due to the sale of loans to investors, including Freddie Mac, with servicing retained which began in late 2016. With the wind-down of mortgage banking operations, we anticipate that broker fee income will decrease while loan servicing fee income will increase due to the multifamily loan securitization that closed in September 2017.
Gain on sale of loans. Gains on the sale of loans, including the change in fair value of loans held for sale, decreased
by $607 thousand to $3.3 million for the year ended December 31, 2017 from a value of $3.9 million for the same period ended December 31, 2016. The gain of $3.3 million for the year ended December 31, 2017 was primarily comprised of a net gain on our multifamily securitization of $3.4 million partially offset by a net loss of $186 thousand related to retail single family mortgage banking operations that were discontinued during the first quarter of 2017. The net gain on our securitization of $3.4 million reflects net proceeds after expenses of the transaction in excess of our recorded investment in the loans including the recognition of a mortgage servicing asset totaling $5.5 million, less a charge of $1.8 million, at the time of sale, reflecting a reserve for our reimbursement obligation to Freddie Mac and further reduced by realized losses on an interest rate swap agreement of $335 thousand that served as a hedge of the securitization transaction. The gain of $3.9 million for the year ended December 31, 2016 consisted primarily of net gains of $2.8 million and $1.1 million from multiple whole loan sales of portfolio loans and mortgage banking activity, respectively.
Noninterest Expense
Our noninterest expense decreased $4.7 million, or 7.7%, to $56.5 million for the year ended December 31, 2017 from $61.2 million for 2016.
The following table presents the components of our noninterest expense for the years ended December 31, 2017 and 2016.
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| | | | | | | | | | | | | | |
| For the Years Ended December 31, |
(Dollars in thousands) | 2017 | | 2016 | | $ Increase (Decrease) | | % Increase (Decrease) |
Noninterest Expense | | | | | | | |
Compensation and related benefits | $ | 36,524 |
| | $ | 38,551 |
| | $ | (2,027 | ) | | (5.3 | )% |
Federal deposit insurance | 1,812 |
| | 1,725 |
| | 87 |
| | 5.0 | % |
Occupancy | 5,155 |
| | 5,477 |
| | (322 | ) | | (5.9 | )% |
Depreciation and amortization | 2,903 |
| | 2,873 |
| | 30 |
| | 1.0 | % |
Professional and regulatory fees | 2,034 |
| | 2,577 |
| | (543 | ) | | (21.1 | )% |
Advertising | 935 |
| | 875 |
| | 60 |
| | 6.9 | % |
Data processing | 3,167 |
| | 3,322 |
| | (155 | ) | | (4.7 | )% |
Operating | 3,286 |
| | 3,970 |
| | (684 | ) | | (17.2 | )% |
Other | 728 |
| | 1,872 |
| | (1,144 | ) | | (61.1 | )% |
Total noninterest expense | $ | 56,544 |
| | $ | 61,242 |
| | $ | (4,698 | ) | | (7.7 | )% |
Compensation and related benefits. Compensation and related benefits expense decreased by $2.0 million, or 5.3%, to $36.5 million for the year ended December 31, 2017 from $38.6 million for 2016. The decrease in expense was primarily due to a net decrease in incentive compensation due to a change in the timing of incentive award grants from the beginning of the year to the end of the year in 2017 as compared to calendar 2016, as well as reduced commission expense associated with the discontinuation of retail mortgage banking operations partially offset by less capitalization of compensation related to those same mortgage banking activities. At December 31, 2017, we employed 266 individuals as compared to 303 staff members at the end of December 31, 2016.
Occupancy. Occupancy expense decreased by $322 thousand, or 5.9%, to $5.2 million for the year ended December 31, 2017 from $5.5 million for the same period in 2016. The majority of this reduction was achieved by reduced rents from consolidating administrative offices and subletting offices previously used for mortgage banking operations, as well as a one-time $109 thousand property tax refund received during the second quarter of 2017 as a result of disputing the assessed value of our one owned branch property. Subject to the decision to open additional strategically located branches or loan production offices, and scheduled lease increases, we expect our rent expenses to be stable as our major administrative offices in Santa Rosa, Manhattan Beach and Irvine, California have adequate capacity to support future growth over the next several years.
Professional and regulatory fees. Professional and regulatory fees decreased by $543 thousand, or 21.1%, to $2.0 million for the year ended December 31, 2017 from $2.6 million for the same period in 2016 due primarily to the change in the Bank’s charter. On September 9, 2016, we converted the Bank from a federally chartered savings and loan to
a California state commercial bank. As a result, the DBO and the FDIC are our primary bank regulators. The Federal Reserve remains the primary federal regulator for the Company. Regulatory fees assessed by the DBO are lower than those we paid when the Bank was federally chartered. In addition, given the timing of our charter change, we were not assessed any DBO regulatory fees until July 2017.
Operating. Operating expense is comprised primarily of costs related to travel, publications, contributions, maintenance and miscellaneous loans fees. Operating expense decreased by $684 thousand, or 17.2%, to $3.3 million for the year ended December 31, 2017 from $4.0 million for the same period in 2016 as a result of administrative office consolidation during 2016, a reduced workforce and our exit from retail mortgage banking operations.
Other. Other noninterest expense decreased by $1.1 million, or 61.1%, to $728 thousand for the year ended December 31, 2017 from $1.9 million for the same period in 2016. Other noninterest expense includes provisions for (expense) or reversals of (income) reserves for off balance sheet liabilities such as undisbursed funds on loans and lines of credit and early payoff/default obligations on sold loans. For the year ended December 31, 2017 and 2016, a reversal of off-balance sheet reserves of $749 thousand and a provision for off-balance sheet reserves of $771 thousand, respectively, were recorded in other noninterest income for these purposes. The decrease in reserves related to off-balance sheet risk period over period reflects a decline in unfunded commitments related to the one non-owner occupied, single family construction development relationship in our portfolio. Other noninterest expense also includes the cost of issuing forgivable down payment assistance loans to borrowers with low-to-moderate income and/or with collateral property located in low-to-moderate income census tracts. As we do not expect to collect any interest or principal on these loans, they are recorded as an expense at the time of origination. For the year ended December 31, 2017 and 2016, these loans totaled $239 thousand and $506 thousand, respectively. Other noninterest expense also includes miscellaneous other office costs such as guard services, moving expenses and shredding services.
Income Tax (Benefit) Expense
For the year ended December 31, 2017, we recorded an income tax benefit of $4.2 million as compared to income tax expense of $1.8 million for the year ended December 31, 2016 with effective tax rates of -6.4% and 3.4%, respectively. We elected to be taxed as an S Corporation until December 1, 2017, at which time we revoked our election in connection with our initial public offering. As a result of that election and H.R.1, the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017, we increased our deferred tax asset and recorded a tax benefit of $5.3 million in December 2017. Additionally, we recognized a $2.9 million tax benefit from the partial deductibility of contingent IPO costs not recognized as GAAP expenses. These benefits were partially offset by tax provisions on earnings at S Corporation rates and C Corporation rates for eleven months and one month of 2017, respectively. Prior to December 1, 2017, we did not pay corporate U.S. federal income tax on our taxable income. Instead, our taxable income was ‘‘passed through’’ to our shareholders. Our tax expense for the year ending December 31, 2016 reflects our liability for California state corporate income taxes that are not ‘‘passed through’’ to our shareholders. See ‘‘S Corporation Status’’ above for a discussion of our status as an S Corporation and ‘‘Pro Forma Income Tax Expense and Net Income’’ below for a discussion on what our income tax expense and net income would have been had we been taxed as a C Corporation.
Pro Forma Income Tax Expense and Net Income
In connection with our initial public offering, we revoked our “Subchapter S” corporation election on December 1, 2017. Prior to that date, as an S-Corporation, we had no U.S. federal income tax expense. We calculate our pro forma net income by adding back our franchise S Corporation tax to net income, and using a combined C Corporation effective tax rate for federal and California income taxes of 42.0%. This calculation reflects only the change in our status as an S Corporation and does not give effect to any other transaction. Our net income for the years ended December 31, 2017 and 2016 was $69.4 million and $52.1 million, respectively. Had we been subject to U.S. federal income tax during these periods, on a pro forma basis, our provision for combined federal and state income tax would have been $27.4 million and $22.7 million, respectively, for the years ended December 31, 2017 and December 31, 2016. As a result of the foregoing factors, our pro forma net income (after U.S. federal and California state income tax) for the years ended December 31, 2017 and December 31, 2016 would have been $37.8 million and $31.3 million, respectively.
Results of operations - Years ended December 31, 2016 and December 31, 2015
Overview
For the year ended December 31, 2016 our net income was $52.1 million as compared to $35.4 million for the year ended December 31, 2015. The increase of $16.7 million, or 47.3%, was attributed primarily to an increase of $9.7 million in net interest income, a $5.6 million greater net reversal of provision for loan losses and a $1.1 million reduction in noninterest expense, as compared to the year ended December 31, 2015. The increase in net interest income was credited to strong organic loan growth, while the reversal of loan reserves reflected continuing improvement in the credit metrics of our loan portfolio. Pre-tax, pre-provision net earnings increased by $11.7 million, or 39.8%, for the year ended December 31, 2016 as compared to the year ended December 31, 2015 largely due to the additional $9.7 million in net interest income.
Net Interest Income
Net interest income increased by $9.7 million, or 11.4%, to $94.6 million for the year ended December 31, 2016 from $84.9 million for 2015. Our net interest margin of 2.04% for the year ended December 31, 2016 declined from our net margin of 2.11% for the year ended December 31, 2015, primarily due to the rate on loan payoffs exceeding the rate achieved on new loan origination volume.
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 and rates paid for the years ended December 31, 2016 and 2015. The average balances are daily averages and include both performing and nonperforming loans.
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| | | | | | | | | | | | | | | | | | | | | | | |
| | | For the Years Ended December 31, |
| | | 2016 | | 2015 |
(Dollars in thousands) | | | Average Balance | | Interest Inc / Exp | | Average Yield/Rate | | Average Balance | | Interest Inc / Exp | | Average Yield/Rate |
Interest-Earning Assets | | | | | | | | | | | | | |
Multifamily residential | | | $ | 2,437,487 |
| | $ | 84,766 |
| | 3.48 | % | | $ | 2,150,897 |
| | $ | 78,345 |
| | 3.64 | % |
Single family residential | | | 1,629,370 |
| | 50,756 |
| | 3.12 | % | | 1,329,581 |
| | 41,556 |
| | 3.13 | % |
Commercial | | | 49,863 |
| | 2,886 |
| | 5.79 | % | | 77,475 |
| | 4,105 |
| | 5.30 | % |
Construction, land and NM | | | 29,993 |
| | 977 |
| | 3.26 | % | | 7,267 |
| | 243 |
| | 3.34 | % |
Total Loans (1) | | | 4,146,713 |
| | 139,385 |
| | 3.36 | % | | 3,565,220 |
| | 124,249 |
| | 3.49 | % |
Securities available-for-sale | | | 402,035 |
| | 4,151 |
| | 1.03 | % | | 343,683 |
| | 2,797 |
| | 0.81 | % |
Securities held-to-maturity (2) | | | 8,570 |
| | 253 |
| | 2.95 | % | | 6,922 |
| | 238 |
| | 3.44 | % |
Cash and cash equivalents | | | 76,003 |
| | 370 |
| | 0.49 | % | | 102,010 |
| | 262 |
| | 0.26 | % |
Total interest-earning assets | | | $ | 4,633,321 |
| | $ | 144,159 |
| | 3.11 | % | | $ | 4,017,835 |
| | $ | 127,546 |
| | 3.17 | % |
Noninterest-earning assets (3) | | | 43,355 |
| | | | | | 22,546 |
| | | | |
Total assets | | | $ | 4,676,676 |
| | | | | | $ | 4,040,381 |
| | | | |
| | | | | | | | | | | | | |
Interest-Bearing Liabilities | | | | | | | | | | | | | |
Transaction accounts (4) | | | $ | 130,573 |
| | $ | 502 |
| | 0.38 | % | | $ | 105,744 |
| | $ | 85 |
| | 0.08 | % |
Money market demand accounts | | | 1,440,129 |
| | 10,506 |
| | 0.73 | % | | 980,467 |
| | 6,712 |
| | 0.68 | % |
Time deposits | | | 1,629,479 |
| | 20,640 |
| | 1.27 | % | | 1,994,662 |
| | 22,353 |
| | 1.12 | % |
Total deposits | | | 3,200,181 |
| | 31,648 |
| | 0.99 | % | | 3,080,873 |
| | 29,150 |
| | 0.95 | % |
FHLB advances | | | 879,237 |
| | 10,219 |
| | 1.16 | % | | 398,193 |
| | 6,073 |
| | 1.53 | % |
Senior debt | | | 93,956 |
| | 6,309 |
| | 6.71 | % | | 93,824 |
| | 6,309 |
| | 6.72 | % |
Junior subordinated debentures | | | 61,857 |
| | 1,348 |
| | 2.18 | % | | 61,857 |
| | 1,101 |
| | 1.78 | % |
Total interest-bearing liabilities | | | $ | 4,235,231 |
| | $ | 49,524 |
| | 1.17 | % | | $ | 3,634,747 |
| | $ | 42,633 |
| | 1.17 | % |
Noninterest-bearing liabilities | | | 51,127 |
| | | | | | 46,275 |
| | | | |
Total stockholders' equity | | | 390,318 |
| | | | | | 359,359 |
| | | | |
Total liabilities and stockholders' equity | | | $ | 4,676,676 |
| | | | | | $ | 4,040,381 |
| | | | |
| | | | | | | | | | | | | |
Net interest spread (5) | | | | | | | 1.94 | % | | | | | | 2.00 | % |
Net interest income/margin (6) | | | | | $ | 94,635 |
| | 2.04 | % | | | | $ | 84,913 |
| | 2.11 | % |
| |
(1) | Loan balance includes portfolio real estate loans, real estate loans held for sale and one $50 thousand non-mortgage loan. Non-accrual loans are included in total loan balances. No adjustment has been made for these loans in the calculation of yields. Interest income on loans includes amortization of deferred loan fees, net of deferred loan costs. Net deferred loan cost amortization totals $9.9 million and $8.9 million for the years ended December 31, 2016 and December 31, 2015, respectively. |
| |
(2) | Securities held to maturity include obligations of states and political subdivisions of $302 thousand and $318 thousand as of December 31, 2016 and December 31, 2015, respectively. Yields are not calculated on a tax equivalent basis. |
| |
(3) | Noninterest earning assets includes the allowance for loan losses. |
| |
(4) | Transaction accounts include both interest and non-interest bearing deposits. |
| |
(5) | Net interest spread is the average yield on total interest-earning assets minus the average rate on total interest-bearing liabilities. |
| |
(6) | Net interest margin is net interest income divided by total interest-earning assets. |
Interest rates and operating interest differential. Increases and decreases in interest income and interest expense result from change in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest 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 during the periods indicated. The effect of changes in volume is determined by multiplying the change in volume by the current period’s average
rate. The effect of rate changes is calculated by multiplying the change in average rate by the prior period’s volume. The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the changes in each.
| | | For the Years Ended December 31, | |
| 2016 vs 2015 | | | | | | | | | | | | | | | |
| Variance Due To | | For the Years Ended December 31, 2022 vs 2021 |
| | | Yield/ | | | | Variance Due To |
(Dollars in thousands) | Volume | | Rate | | Total | (Dollars in thousands) | Volume | | Yield/Rate | | Total |
Interest-Earning Assets | | | | | | Interest-Earning Assets | | | | | |
Multifamily residential | $ | 10,087 |
| | $ | (3,665 | ) | | $ | 6,422 |
| Multifamily residential | $ | 6,630 | | | $ | 3,849 | | | $ | 10,479 | |
Single family residential | 9,339 |
| | (139 | ) | | 9,200 |
| Single family residential | 4,226 | | | 9,931 | | | 14,157 | |
Commercial | (1,570 | ) | | 351 |
| | (1,219 | ) | |
Construction, land and NM | 740 |
| | (6 | ) | | 734 |
| |
Commercial real estate | | Commercial real estate | (489) | | | 269 | | | (220) | |
Construction and land | | Construction and land | 161 | | | (17) | | | 144 | |
Total Loans | 18,596 |
| | (3,459 | ) | | 15,137 |
| Total Loans | 10,528 | | | 14,032 | | | 24,560 | |
Securities available-for-sale | 524 |
| | 830 |
| | 1,354 |
| |
Securities held-to-maturity | 52 |
| | (37 | ) | | 15 |
| |
Investment securities | | Investment securities | 17 | | | 5,904 | | | 5,921 | |
Cash and cash equivalents | (80 | ) | | 188 |
| | 108 |
| Cash and cash equivalents | (12) | | | 2,565 | | | 2,553 | |
Total interest-earning assets | $ | 19,092 |
| | $ | (2,478 | ) | | $ | 16,614 |
| Total interest-earning assets | 10,533 | | | 22,501 | | | 33,034 | |
| | | | | | |
Interest-Bearing Liabilities | | | | | | Interest-Bearing Liabilities | | | | | |
Transaction accounts | $ | 24 |
| | $ | 393 |
| | $ | 417 |
| Transaction accounts | 26 | | | 47 | | | 73 | |
Money market demand accounts | 3,328 |
| | 466 |
| | 3,794 |
| Money market demand accounts | 2,721 | | | 12,263 | | | 14,984 | |
Time deposits | (4,404 | ) | | 2,691 |
| | (1,713 | ) | Time deposits | (2,902) | | | 8,716 | | | 5,814 | |
Total deposits | (1,052 | ) | | 3,550 |
| | 2,498 |
| Total deposits | (155) | | | 21,026 | | | 20,871 | |
FHLB advances | 5,879 |
| | (1,732 | ) | | 4,147 |
| FHLB advances | 1,588 | | | 2,781 | | | 4,369 | |
Junior subordinated debentures | | Junior subordinated debentures | — | | | 1,000 | | | 1,000 | |
Senior debt | 9 |
| | (9 | ) | | — |
| Senior debt | 8 | | | (9) | | | (1) | |
Junior subordinated debentures | — |
| | 247 |
| | 247 |
| |
Total interest-bearing liabilities | $ | 4,836 |
| | $ | 2,056 |
| | $ | 6,892 |
| Total interest-bearing liabilities | 1,441 | | | 24,798 | | | 26,239 | |
| | | | | | |
Net Interest Income | | | | | | Net Interest Income | $ | 9,092 | | | $ | (2,297) | | | $ | 6,795 | |
Net Interest Income | $ | 14,256 |
| | $ | (4,534 | ) | | $ | 9,722 |
| |
as a hedge of interest rate risk, as we can strategically control the duration of those funds. A discussion of instruments used to mitigate interest rate risk can be found under Part II - Item 7A. ‘‘Quantitative and Qualitative Disclosures About Market Risk.’’