Banc of California, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following is management’s discussion and analysis of the major factors that influenced our results of operations and financial condition as of and for the three and nine months ended September 30, 2023. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2022 and with the unaudited consolidated financial statements and notes thereto set forth in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2023.

Executive Overview

We are focused on providing core banking products and services, including customized and innovative banking and lending solutions, designed to cater to the unique needs of California’s diverse businesses, entrepreneurs and communities through our 26 full service branches in California, extending from San Diego to Santa Barbara. Through our dedicated professionals, we are committed to servicing and building enduring relationships by providing a higher standard of banking. We offer a

variety of financial products and services designed to serve the banking and financial needs of our target clients. We also acquired Deepstack Technologies in 2022 to be able to offer full stack payment processing solutions and further our ability to serve as the hub of our clients' financial services ecosystem.

Economy and Banking Industry Impact

Economic uncertainty and concerns regarding the stability of the U.S. banking system following recent bank failures earlier in the year contributed to a challenging operating environment for our Company in the first half of 2023. Additionally, the Federal Reserve continued to raise the short-term federal funds rate, which increased 100 basis points since the start of the year through September 2023, as inflation persists. Since the beginning of 2022 through September 2023, the Federal Reserve has increased the federal funds target rate 525 basis points. As our assets and liabilities are primarily monetary in nature, the effect of changes in interest rates has a significant impact on our performance.

The rising interest rate environment may lead to lower demand for loans, higher credit losses, and decreased values for our investment securities, among other negative effects. Additionally, it may create more intense competition for low-cost deposits, potential for deposit outflows as rate-sensitive depositors seek higher yielding products or investment alternatives, and increased deposit rates and borrowing costs. The recent industry events could further accelerate the deposit outflows experienced by some mid-sized banks.

During the first quarter of 2023, in response to volatility in the financial markets, we proactively performed liquidity-enhancing measures, including additional advances from the FHLB and draws on available FRB facilities. While these actions had a negative impact on our level of profitability and net interest margin, we believe it was prudent from a risk management perspective. As the markets stabilized, we used cash to pay down borrowings and other liabilities reducing the excess liquidity that we carried in the first half of 2023. As of September 30, 2023, we had primary and secondary liquidity availability of just over $3.67 billion, or 2.1 times our uninsured and uncollateralized deposits.

Proposed Merger with PacWest

On July 25, 2023, the Company and PacWest announced the execution of a definitive merger agreement pursuant to which the companies will combine in an all-stock merger transaction. Pursuant to the terms and conditions of the agreement, PacWest will merge into the Company, with the Company surviving, and the Bank will merge into PacWest Bank, with PacWest Bank surviving as wholly-owned subsidiary of the Company. The combined holding company and bank will operate under the Banc of California name and brand following closing of the transaction. At the closing of the merger, PacWest stockholders will be entitled to receive 0.6569 of a share of the Company’s common stock for each share held of PacWest common stock.

In connection with entering into the definitive merger agreement, the Company also entered into the Investment Agreements with the Warburg Investors and the Centerbridge Investors. Subject to the terms and conditions of the Investment Agreements, at closing, the Investors will invest an aggregate of $400 million for newly issued equity securities substantially concurrently with, and subject to, closing of the merger. The proceeds from this capital raise are expected to be utilized in conjunction with other planned actions to reposition the combined company’s balance sheet. It is expected that, after closing the transaction, the combined company will repay approximately $13 billion in wholesale borrowings and high-cost deposits using proceeds from the sale of certain loan and investment securities assets. The Bank has also entered into an aggregate of $3.1 billion notional amount in interest rate swaptions to hedge interest rate risk and a contingent forward loan sale agreement to lock in proceeds for certain asset sales contemplated in connection with the closing of the transaction.

Upon completion of the proposed transaction, (a) the shares issued to PacWest stockholders in the merger are expected to represent approximately 47% of the outstanding shares of the combined company, (b) the shares issued to the Investors in the equity capital raise transaction discussed above are expected to represent approximately 19% of the outstanding shares of the combined company and (c) the shares of Banc of California common stock that are outstanding immediately prior to completion of the merger are expected to represent approximately 34% of the outstanding shares of the combined company.

On October 19, 2023, the Board of Governors of the Federal Reserve System granted its approval of the merger. In addition, on October 5, 2023, the California Department of Financial Protection and Innovation granted its approval of the bank merger. No further regulatory approvals are required to complete the proposed transaction. Banc of California and PacWest will each hold a special meeting of its respective stockholders in connection with the transaction on November 22, 2023. The consummation of the proposed transaction is expected to close on or about November 30, 2023, subject to the satisfaction of the remaining closing conditions set forth in the merger agreement, including receipt of the requisite stockholder approvals, and the concurrent closing of a $400 million equity capital raise.

We are monitoring the economic environment and its impact on the projected combined company’s opening day and post-restructuring balance sheets and the combined company’s projected performance in future periods as compared to the estimates and projections set forth in the Investor Presentation dated July 25, 2023 (the “Investor Presentation”).

After considering developments occurring subsequent to the issuance of the Investor Presentation, including the volatility and changes in the interest rate environment, the relative performance of the two companies, the potential impacts on the opening day and post-restructuring balance sheets, and refinements to many of the assumptions and estimates used in the creation of projections included in the Investor Presentation, we are not aware of any material changes to the projected 2024 EPS range or CET1 regulatory capital levels for the combined company as stated in the Investor Presentation.

The recent volatility and resulting increase in longer term (7 and 10-year) interest rates decreased the current valuation of PacWest’s portfolio of AFS securities which, with the corresponding increase in unrealized losses included in accumulated other comprehensive income (AOCI), reduced PacWest’s tangible book value. If these conditions persist through the closing date of the merger, there would be a corresponding decrease in the opening day tangible book value of the combined company as compared to the projections included in the Investor Presentation. In addition, PacWest’s third quarter 2023 net income was lower than forecasted in the estimates set forth in the Investor Presentation, which could also negatively impact the opening day tangible book value of the combined company. The non-interest bearing deposit percentage at PacWest has decreased from the projections used in the Investor Presentation, which could impact the percentage of non-interest bearing deposits forecasted in the opening day and the post-restructuring balance sheets.

The economic environment remains dynamic with heightened levels of volatility in interest rates, market levels and potentially other economic impacts. Accordingly, we will continue to monitor the effects of these and other potential impacts on the financial projections and estimates included in the Investor Presentation.

Balance Sheet Repositioning in Connection with the Proposed Merger

While it is not a condition to consummate the proposed merger with PacWest, contingent upon the merger closing, the Company and PacWest plan to sell an aggregate of $7.0 billion of the assets, collectively, at or shortly following closing. The Company has identified the following Banc of California assets, with each portfolio having been hedged for interest rate risk:

• $1.8 billion SFR loan portfolio: The Company entered into a contingent forward sale agreement with affiliates of J.P. Morgan with respect to the SFR loan portfolio, which is comprised of $1.8 billion in assets. The forward sale agreement is contingent upon receipt of approval for the closing of the bank merger. Should the merger not close for any reason, we intend to continue to hold the SFR loan portfolio for investment. The contingent forward loan sale agreement contains customary terms and conditions associated with a whole loan sale and we expect to close the forward loan sale shortly after closing of the merger. Pursuant to the terms of the agreement, the purchase price is subject to adjustment reflecting at-market fees based on the additional time for settlement from November 8, 2023. It is anticipated that the Company will transfer such mortgage portfolio as soon as possible after the closing of the merger, which may take up to a week post-closing due to operational considerations. If the forward loan sale agreement terminates before the completion of the merger, then it is possible that the Company will be unable to sell such assets on the terms that are at least as favorable to us as the terms set forth in the forward loan sale agreement.
• $1.6 billion multi-family residential loan portfolio: The $1.6 billion multi-family residential loan portfolio is currently being marketed to several potential counterparties for sale, pending closing of the merger. The Company has received multiple external bids for such assets and plans to implement the structure of the SFR sale agreement and target a date in mid to late November for close. The Company anticipates that the sale and transfer of this portfolio would be consummated approximately one week following the closing of the merger. Completion of this multi-family forward sale transaction is contingent upon (a) the finalization of a forward sale agreement to sell the portfolio, and (b) the closing of the merger occurring prior to the expiration of the term of such forward sale agreement, as it may be extended.
• $1.2 billion of AFS and HTM securities (the “Company bond portfolio”), which may include, among others, collateralized mortgage obligations (“CMO”), mortgage-backed securities (“MBS”), taxable municipal bonds and collateralized loan obligations (“CLO”): The Company bond portfolio is comprised of liquid instruments with CUSIPs

for which there are currently active and liquid markets. The plan is to sell the Company bond portfolio over a one to two week period immediately post-closing of the merger. Sale of the Company bond portfolio is dependent on (a) market liquidity and (b) market pricing (other than decreases caused by market base interest rates). For example, if the market value for certain securities in the Company bond portfolio were to decrease substantially due to the widening of credit spreads, then such decrease could have an adverse effect on the sale due to the un-hedged impact on equity.

Additionally, PacWest has identified for potential sale $2.3 billion of its AFS securities, which may include, among others, commercial and residential MBS, CMO, treasury bonds and municipal bonds. Proceeds of the asset sales along with excess cash are expected to be utilized in the repayment of the merged company’s wholesale borrowings.

Financial Highlights

For the third quarter of 2023, net income was $42.6 million, or $0.74 per diluted common share. This compares to net income of $17.9 million, or $0.31 per diluted common share, for the second quarter of 2023 and net income of $24.2 million, or $0.40 per diluted common share, for the third quarter of 2022.

On an adjusted basis, net income was $17.1 million for the quarter, or $0.30 per diluted common share, for the third quarter of 2023.(1) This compares to adjusted net income of $18.4 million, or $0.32 per diluted common share, for the second quarter of 2023, and $26.7 million, or $0.44 per diluted common share for the third quarter of 2022.(1)

The third quarter of 2023 included a $46.2 million pre-tax mark-to-market gain on derivative instruments used to hedge the interest rate risk associated with various assets on the Company’s balance sheet, in anticipation of the sale of such assets in connection with the proposed merger with PacWest. The gain was partly offset by $9.3 million of acquisition, integration and transaction costs.

Third quarter of 2023 highlights:

• Net income of $42.6 million, or $0.74 per diluted common share, up 138% from the prior quarter as the bank strategically positioned the balance sheet ahead of the merger, which included a $46.2 million pre-tax gain from derivative instruments, partly offset by $9.3 million of transaction costs.
• Stable overall deposit mix, with the period-end noninterest-bearing deposit percentage consistent with the prior quarter at 36% of total deposits.
• Addition of new clients with noninterest-bearing deposits, which contributed inflows of $52.2 million in the quarter and $201.5 million year-to-date.
• Net interest margin improvement of 8 basis points from 3.11% to 3.19% in comparison to the prior quarter, as the increase in the yield on loans and securities exceeded the increase in the cost of funds.
• Disciplined noninterest expense management, with total noninterest expense of $56.2 million reflecting an increase of $7.0 million over the prior quarter. Excluding the impact of $9.3 million of acquisition, integration and transaction costs, adjusted noninterest expense(1) decreased $2.2 million to $46.2 million for the third quarter.
• High liquidity levels, with immediately available on-balance sheet liquidity and unused borrowing capacity of $3.67 billion. Available liquidity was 2.1 times the level of uninsured and uncollateralized deposits, which was consistent with the prior quarter.
• Strong capital ratios well above the regulatory thresholds for "well capitalized" banks, including a 14.83% Total risk-based capital ratio, 12.53% Tier 1 capital ratio, 12.53% CET1 capital ratio and 10.13% Tier 1 leverage ratio.
• Low unrealized losses relative to capital, with AFS unrealized pre-tax losses of $51.9 million on securities of $915.1 million, representing 3.9% of CET1 capital. Total AFS and HTM unrealized pre-tax losses of $129.9 million on total securities of $1.24 billion represented 9.8% of CET1 capital.
• Continued growth in book value and tangible book value, with book value per share of $17.44, up from $16.67, and tangible book value per share of $15.34, up from $14.56.(1)

(1) Non-GAAP measures; refer to section 'Non-GAAP Measures'

CRITICAL ACCOUNTING ESTIMATES

We follow accounting and reporting policies and procedures that conform, in all material respects, to GAAP and to practices generally applicable to the financial services industry, the most significant of which are described in Note 1 — Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements included in Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the SEC. The preparation of Consolidated Financial Statements in conformity with GAAP requires management to make judgments and accounting estimates that affect the amounts reported for assets, liabilities, revenues and expenses on the Consolidated Financial Statements and accompanying notes, and amounts disclosed as contingent assets and liabilities. While we base estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

1 Non-GAAP measures; refer to section “Non-GAAP Measures”

Accounting estimates are necessary in the application of certain accounting policies and procedures that are particularly susceptible to significant change. Critical accounting policies are defined as those that require the most complex or subjective judgment and are reflective of significant uncertainties, and could potentially result in materially different results under different assumptions and conditions. Management has identified our most critical accounting policies and accounting estimates as: ACL, business combinations, value of acquired loans, goodwill and deferred income taxes. See Note 1 — Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements (Unaudited) included in Item 1 for a description of these policies.

ACL - Loans. The ACL on loans is estimated on a quarterly basis and represents management’s estimate of CECL in our loan portfolio. The ACL estimate is based on the accounting standard commonly known as CECL. Under the CECL method, pools of loans with similar risk characteristics are collectively evaluated while loans that no longer share risk characteristics with loan pools are evaluated individually. Collective loss estimates are determined by applying loss factors, designed to estimate current expected credit losses, to amortized cost balances over the remaining life of the collectively evaluated portfolio. The ALL includes qualitative adjustments to bring the allowance to the level management believes is appropriate based on factors that have not otherwise been fully accounted for, including those described in the federal banking agencies’ joint interagency policy statement on ALL. These factors include, among others, inherent imprecision in forecasting economic variables, including determining the depth and duration of economic cycles and their impact to relevant economic variables; qualitative adjustments based on our evaluation of different forecast scenarios and known recent events impacting relevant economic variables; data factors that address the risk that certain model inputs may not reflect all available information including (i) risk factors that have not been fully addressed in internal risk ratings, (ii) changes in lending policies and procedures, (iii) changes in the level and quality of experience held by lending management, (iv) imprecision in the risk rating system and (v) limitations in data available for certain loan portfolios. The ACL process also includes challenging and calibrating the model and model results against observed information, trends and events within the loan portfolio, among others. The ACL and provision for credit losses include amounts and changes from both the ALL and the RUC.

ACL - AFS Securities. For AFS securities which are in an unrealized loss position, we assess whether we intend to sell, or it is more likely than not, that we will be required to sell the security before recovery of the amortized cost basis. If either of the criteria is met, the amortized cost basis of the security is written down to fair value through income. For AFS securities that do not meet the aforementioned criteria, we evaluate whether the decline in fair value has resulted from an actual or estimated credit loss event or other factors. In making this assessment, we consider the extent to which fair value is less than amortized cost, changes to the rating of the security, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss is likely, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, an ACL is recorded as a valuation allowance for the estimated credit loss, reducing the carrying value of the securities on the balance sheet and limited by the amount that the fair value is less than the amortized cost basis. Changes in the ACL are recorded as a provision for credit loss. Losses are charged against the allowance when we believe the uncollectability of an AFS security has been confirmed or if either of the criteria regarding intent or requirement to sell is met.

Business Combinations. Business combinations are accounted for using the acquisition method of accounting under ASC Topic 805 - Business Combinations. Under the acquisition method, the Company measures the identifiable assets acquired, including identifiable intangible assets, and liabilities assumed in a business combination at fair value on acquisition date. Goodwill is generally determined as the excess of the fair value of the consideration transferred, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.

We allocate the fair value of the purchase consideration to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The fair values of other intangibles are determined utilizing information available near the acquisition date based on expectations and assumptions that are deemed reasonable by management. The estimates used to determine the fair values of assets and liabilities acquired in a business combination can be complex and require judgment, as such we typically engage third-party valuation specialists for significant items.

For example, we generally value core deposit intangible assets using a discounted cash flow approach, which require a number of critical estimates that include, but are not limited to, future expected cash flows from depositor relationships, expected "decay" rates, and the determination of discount rates. We use the multi-period excess earnings method to value developed technology, the foregone cash flow method to value client relationships, and the relief from royalty method to value trademarks. Non-compete agreements are estimated using a with and without scenario where cash flows are projected through the term of the non-compete agreement assuming the agreement is in place and compared to cash flows assuming it is not in place. In valuing these intangibles, we make forward looking assumptions regarding expected future revenues and expenses to develop the underlying forecasts, applied contributory asset charges, discount rates, useful lives and other estimates. These critical estimates are difficult to predict and may result in impairment charges in future periods if actual results materially differ from the estimated assumptions utilized in our initial valuation of net assets and liabilities acquired.

Goodwill. Goodwill represents the excess purchase price of businesses acquired over the fair value of the identifiable net assets acquired. Goodwill is not subject to amortization and is evaluated for impairment at least annually, normally during the fourth fiscal quarter, or more frequently in the interim if events occur or circumstances change indicating impairment may have occurred. The determination of whether impairment has occurred is based on an assessment of several factors, including, but not limited to, operating results, business plans, economic projections, anticipated future cash flows, and current market data. Any impairment identified as part of this testing is recognized through a charge to noninterest expense.

The assessment of impairment discussed above incorporate inherent uncertainties, including projected operating results and future market conditions, which are often difficult to predict and may result in impairment charges in future periods if actual results materially differ from the estimated assumptions utilized in our forecasts.

Acquired Loans. At acquisition date, loans are evaluated to determine whether they meet the criteria of a PCD loan. PCD loans are loans that in management’s judgment have experienced more than insignificant deterioration in credit quality since origination. Factors that indicate a loan may have experienced more than insignificant credit deterioration include delinquency, downgrades in credit rating, non-accrual status, and other negative factors identified by management at the time of initial assessment. PCD loans are initially recorded at fair value, with the resulting non-credit discount or premium being amortized or accreted into interest income using the interest method. In addition to the fair value adjustment, at the date of acquisition, an ACL is established with a corresponding increase to the overall acquired loan balance. This initial ACL is determined using our application of the CECL method.

Acquired loans that are not considered PCD loans (“non-PCD loans”) are also recognized at fair value at the acquisition date, with the resulting credit and non-credit discount or premium being amortized or accreted into interest income using the interest method. In addition to the fair value adjustment, at the time of acquisition, we establish an initial ACL for acquired non-PCD loans through a charge to the provision for credit losses. This initial ACL is determined using our application of the CECL method.

Subsequent to acquisition date, the ACL for both PCD and non-PCD loans is determined using the same methodology to determine current expected credit losses that is applied to all other loans in our portfolio.

The estimates used to determine the fair values of PCD and non-PCD acquired loans can be complex and require significant judgment regarding items such as default rates, timing and amount of future cash flows, prepayment rates and other factors. These critical estimates are difficult to predict and may result in provisions for credit losses in future periods if actual losses materially differ from the estimated assumptions utilized in our initial valuation of acquired loans.

Deferred Taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Deferred tax assets are also recognized for operating loss and tax credit carryforwards. Accounting guidance requires that companies assess whether a valuation allowance should be established against the deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. In assessing the realization of deferred tax assets, management will continue to evaluate both positive and negative evidence on a quarterly basis, including considering the four possible sources of future taxable income, such as future reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in prior carryback year(s), and future tax planning strategies.

Although we believe our assessments of the realizability of deferred income taxes are reasonable, no assurance can be given that their realizability will not be different from that which is reflected in our net deferred tax asset balance.

Tax positions that are uncertain but meet a more-likely-than-not recognition threshold are initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position meets the more likely than not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment.

We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Although we believe our reserves are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made.

Recently Issued Accounting Pronouncements Not Yet Adopted

See Note 1 - Summary of Significant Accounting Policies.

Non-GAAP Financial Measures

Under Item 10(e) of SEC Regulation S-K, public companies disclosing financial measures in filings with the SEC that are not calculated in accordance with GAAP must also disclose, along with each non-GAAP financial measure, certain additional information, including a presentation of the most directly comparable GAAP financial measure, a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP financial measure, as well as a statement of the reasons why the company's management believes that presentation of the non-GAAP financial measure provides useful information to investors regarding the company's financial condition and results of operations and, to the extent material, a statement of the additional purposes, if any, for which the company's management uses the non-GAAP financial measure.

Tangible assets, tangible equity, tangible common equity, tangible common equity to tangible assets, tangible common equity per common share, average tangible common equity, return on average tangible common equity, adjusted noninterest income, adjusted noninterest expense, adjusted noninterest income to adjusted total revenue, adjusted noninterest expense to average total assets, pre-tax pre-provision (PTPP) income, adjusted total revenue, adjusted noninterest expense, adjusted PTPP income, PTPP income ROAA, adjusted PTPP income ROAA, efficiency ratio, adjusted efficiency ratio, adjusted net income, adjusted net income available to common stockholders, net income available to common stockholders after adjustments for intangible assets, adjusted diluted earnings per share (EPS), adjusted return on average assets (ROAA) and adjusted common equity tier 1 (CET 1) constitute supplemental financial information determined by methods other than in accordance with GAAP. These non-GAAP measures are used by management in its analysis of the Company's performance.

Tangible assets and tangible equity are calculated by subtracting goodwill and other intangible assets from total assets and total equity. Tangible common equity is calculated by subtracting preferred stock, as applicable, from tangible equity. Return on average tangible common equity is calculated by dividing net income available to common stockholders, after adjustment for amortization of intangible assets, by average tangible common equity. Banking regulators also exclude goodwill and other intangible assets from stockholders' equity when assessing the capital adequacy of a financial institution.

PTPP income is calculated by adding net interest income and noninterest income (total revenue) and subtracting noninterest expense. Adjusted PTPP income is calculated by adding net interest income and adjusted noninterest income (adjusted total revenue) and subtracting adjusted noninterest expense. PTPP income ROAA is calculated by dividing annualized PTPP income by average assets. Adjusted PTPP income ROAA is calculated by dividing annualized adjusted PTPP income by average assets. Efficiency ratio is calculated by dividing noninterest expense by total revenue. Adjusted efficiency ratio is calculated by dividing adjusted noninterest expense by adjusted total revenue.

Adjusted net income is calculated by adjusting net income for tax-effected noninterest income and noninterest expense adjustments. Adjusted ROAA is calculated by dividing annualized adjusted net income by average assets. Adjusted net income available to common stockholders is calculated by removing the impact of preferred stock redemptions from adjusted net income. Adjusted diluted earnings per share is calculated by dividing adjusted net income available to common stockholders by the weighted average diluted common shares outstanding.

Common equity tier 1 and the common equity tier 1 ratio are defined by regulatory capital rules. Adjusted CET 1 is calculated by subtracting net unrealized losses (net of tax) on securities from CET 1 capital and provided to reflect management’s assessment of capital impacts from net unrealized losses on securities.

Management believes the presentation of these financial measures adjusting the impact of these items provides useful supplemental information that is essential to a proper understanding of the financial results and operating performance of the Company. This disclosure should not be viewed as a substitute for results determined in accordance with GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.

The following tables provide reconciliations of the non-GAAP measures with financial measures defined by GAAP.

(1) Non-GAAP measure.

(1) Non-GAAP measure.

(2) Adjustments shown net of a statutory tax rate of 29.6%.

(1) Represents the mark-to-market gain on derivative instruments, including interest rate swaptions and the contingent forward loan sale agreement on the SFR loan portfolio executed concurrently with the announcement of the proposed merger with PacWest.

(2) Non-GAAP measure.

(3) Ratio presented on an annualized basis.

(1) Non-GAAP measure.

(2) Ratio presented on an annualized basis.

(1) Net income for the three and nine months ended September 30, 2023 includes a $46.2 million pre-tax mark-to-market gain on derivative instruments partially offset by acquisition costs of $9.3 million.

(2) Net income and adjusted net income for the nine months ended September 30, 2022 includes a $31.3 million pre-tax reversal of credit losses due to the recovery from the settlement of a previously charged-off loan; there is no similar recovery in any of the other periods presented. The Bank previously recognized a $35.1 million charge-off for this loan during the third quarter of 2019.

(3) Tax impact of adjustments shown at a statutory tax rate of 29.6%.

(4) Non-GAAP measure.

(5) Ratio presented on an annualized basis.

(6) Represents adjusted net income available to common stockholders divided by average diluted common shares.

(1) September 30, 2023 presented to reflect management’s assessment of capital impact from net unrealized losses on securities. Statutory tax rate of 29.6% used for calculation purposes.

(2) Non-GAAP measure.

RESULTS OF OPERATIONS

Net Interest Income

The following table presents interest income, average interest-earning assets, interest expense, average interest-bearing liabilities, and their corresponding yields and costs expressed both in dollars and rates for the three months ended September 30, 2023, June 30, 2023 and September 30, 2022:

($ in thousands)

(1) Includes average loans held for sale of $4.1 million, $4.4 million and $4.2 million for the three months ended September 30, 2023, June 30, 2023 and September 30, 2022,which are included in other assets in the accompanying consolidated statements of financial condition.

(2) Total loans are net of deferred fees, related direct costs, premiums and discounts, but exclude the ACL. Nonaccrual loans are included in the average balance. Interest income includes net (amortization) accretion of deferred loan (costs) fees and purchased (premiums) discounts of $0.1 million, $(1.0) million and $0.1 million for the three months ended September 30, 2023, June 30, 2023 and September 30, 2022.

(3) Includes average balance of FHLB, FRB and other bank stock at cost and average time deposits with other financial institutions.

(4) Includes average balance of bank-owned life insurance of $129.3 million, $128.4 million and $125.6 million for the three months ended September 30, 2023, June 30, 2023 and September 30, 2022.

(5) Annualized net interest income divided by average interest-earning assets.

(6) Total deposits is the sum of interest-bearing deposits and noninterest-bearing deposits. The cost of total deposits is calculated as annualized total interest expense on deposits divided by average total deposits.

(7) Total funding is the sum of interest-bearing liabilities and noninterest-bearing deposits. The cost of total funding is calculated as annualized total interest expense divided by average total funding.

Three Months Ended September 30, 2023 Compared to Three Months Ended June 30, 2023

Net interest income decreased $0.4 million, or 0.6%, to $69.2 million for the third quarter primarily due to lower average interest-earning assets partially offset by net interest margin expansion.

Average interest-earning assets of $8.61 billion decreased $360.4 million from the prior quarter as the Company used cash to pay down FHLB borrowings and other liabilities reducing the excess liquidity that was carried in the prior quarter. The net interest margin increased 8 basis points to 3.19% for the third quarter as average interest-earning assets yield increased 16 basis points while the average cost of funds increased 9 basis points.

The yield on average interest-earning assets increased 16 basis points to 5.36% for the third quarter from 5.20% in the second quarter mainly due to higher yields on loans, securities and other interest-earning assets. The yield on average loans increased 10 basis points to 5.38% during the third quarter as a result of higher market interest rates and changes in portfolio mix from originations and payoffs. The yield on average investment securities increased 34 basis points to 5.17% due mainly to rate resets in the collateralized loan obligations (CLO) portfolio.

The average cost of funds increased 9 basis points to 2.29% for the third quarter from 2.20% in the second quarter due mainly to higher market interest rates and changes in the balance sheet mix. The average cost of total deposits increased 19 basis points to 1.86% for the third quarter compared to 1.67% in the second quarter. The average cost of interest-bearing liabilities increased 13 basis points to 3.21% for the third quarter from 3.08% in the second quarter. Average noninterest-bearing deposits decreased $80.5 million for the third quarter compared to the second quarter and average total deposits decreased $83.2 million.

Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

Net interest income for the third quarter of 2023 decreased $10.2 million, or 12.8%, to $69.2 million compared to $79.4 million for the same 2022 period. Net interest income for the third quarter of 2023 was impacted by higher market interest rates and changes in the balance sheet mix, which was partially offset by higher average yields on interest-earning assets.

The net interest margin decreased 39 basis points to 3.19% for the third quarter of 2023 as average cost of total funding increased 150 basis points while the average interest-earning assets yield increased 103 basis points.

The yield on average interest-earning assets increased 103 basis points to 5.36% for the third quarter of 2023 from 4.33% for the same 2022 period mainly due to higher market interest rates offset by changes in the mix of interest-earning assets. The yield on average loans increased 84 basis points to 5.38% compared to the same 2022 period as a result of the impact of higher market interest rates offset by changes in portfolio mix. The yield on average investment securities increased 179 basis points to 5.17% for the third quarter of 2023, compared to 3.38% for the same 2022 period. Average loans represented 82% of average earnings assets for the three months ended September 30,

2023 compared to 83% for the three months ended September 30, 2022. Average loans decreased by $267.8 million due mainly to lower average warehouse balances and all other loan categories as loan demand slowed amid the high interest rate environment and uncertain economic outlook.

The average cost of funds increased 150 basis points to 2.29% for the third quarter of 2023, from 0.79% for the same 2022 period, due mostly to higher market interest rates as the average effective Federal Funds rate increased 308 basis points to 5.26% for the third quarter of 2023 from 2.18% in the same 2022 period and changes in the balance sheet mix. The average cost of total deposits increased 139 basis points to 1.86% for the third quarter of 2023 compared to the same 2022 period. The cost of average interest-bearing liabilities increased 201 basis points to 3.21% for the third quarter of 2023 from 1.20% for the same 2022 period and included a 210 basis point increase in the cost of average interest-bearing deposits to 2.87%. Average noninterest-bearing deposits decreased $510.0 million for the third quarter of 2023 compared to the same 2022 period and average deposits decreased $823.6 million. Average noninterest-bearing deposits represented 35% of total average deposits for the third quarter of 2023 and 38% for the third quarter of 2022.

The following table presents interest income, average interest-earning assets, interest expense, average interest-bearing liabilities, and their corresponding yields and costs expressed both in dollars and rates, on a consolidated operations basis, for the nine months ended September 30, 2023 and 2022:

($ in thousands)

(1) Includes average loans held for sale of $4.3 million and $3.8 million for the nine months ended September 30, 2023 and 2022, which are included in other assets in the accompanying consolidated statements of financial condition.

(2) Total loans are net of deferred fees, related direct costs, premiums and discounts, but exclude the ACL. Nonaccrual loans are included in the average balance. Interest income includes net (amortization) accretion of deferred loan (costs) fees and purchased (premiums) discounts of $(0.5) million and $(0.5) million for the nine months ended September 30, 2023 and 2022 are included in interest income.

(3) Includes average balance of FHLB, FRB and other bank stock at cost and average time deposits with other financial institutions.

(4) Includes average balance of bank-owned life insurance of $128.4 million and $124.8 million for the nine months ended September 30, 2023 and 2022.

(5) Annualized net interest income divided by average interest-earning assets.

(6) Total deposits is the sum of interest-bearing deposits and noninterest-bearing deposits. The cost of total deposits is calculated as annualized total interest expense on deposits divided by average total deposits.

(7) Total funding is the sum of interest-bearing liabilities and noninterest-bearing deposits. The cost of total funding is calculated as annualized total interest expense divided by average total funding.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Net interest income decreased $22.2 million, or 9.5%, to $211.9 million for the nine months ended September 30, 2023 from the same period in 2022 due primarily to higher funding costs from higher market interest rates, changes in the balance sheet mix, and the enhanced liquidity management strategies in the first half of 2023 due to the operating environment.

The net interest margin decreased 32 basis points to 3.24% as the average cost of funds increased 150 basis points while the average interest-earning assets yield increased 110 basis points.

The yield on average interest-earning assets increased 110 basis points to 5.18% for the nine months ended September 30, 2023 from 4.08% for the same period in 2022 due mainly to higher market interest rates and changes in the mix of interest-earning assets. The yield on average loans increased 86 basis points to 5.24% for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022. The yield on average investment securities increased 211 basis points to 4.89% for the same period. Average loans represented 80% of average earnings assets for the nine months ended September 30, 2023 compared to 83% for the nine months ended September 30, 2022. Average loans decreased by $248.1 million due mainly to lower average warehouse balances, partially offset by organic loan growth in other loan categories.

The average cost of funds increased 150 basis points to 2.06% for the nine months ended September 30, 2023 from 0.56% for the nine months ended September 30, 2022 due mainly to higher market interest rates and changes in the balance sheet mix. The average cost of total deposits increased 134 basis points to 1.58% for the nine months ended September 30, 2023 compared to the same period in 2022. The average cost of interest-bearing liabilities increased 209 basis points to 2.93% for the nine months ended September 30, 2023 compared to 0.84% for the same period in 2022 driven primarily by a 210 basis point increase in the cost of average interest-bearing deposits to 2.49% from 0.39% for the same period in 2022. The increase in the cost of these funding sources was mainly due to the impact of higher market interest rates as the average effective Federal Funds rate increased 389 basis points to 4.92% for the nine months ended September 30, 2023 from 1.03% in the same period in 2022. Average noninterest-bearing deposits decreased $356.8 million for the nine months ended September 30, 2023 compared to the same period in 2022 and average total deposits decreased $670.7 million. Average noninterest-bearing deposits represented 36% of total average deposits for the nine months ended September 30, 2023 compared to 38% for the same period in 2022.

Rate/Volume Analysis

The following table presents the changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities. The information provided presents the changes attributable to: (i) changes in volume multiplied by the prior rate; and (ii) changes in rate multiplied by the prior volume. Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

($ In thousands)

66

Provision for Credit Losses

The provision for credit losses is charged to operations and is adjusted in each period to a level required to cover current expected credit losses in our loan portfolio and unfunded commitments. The following table presents the components of our provision for credit losses:

($ in thousands)

Three Months Ended September 30, 2023 Compared to Three Months Ended June 30, 2023

The provision for credit losses was $5.0 million for the third quarter and related entirely to the provision for loan losses, which was driven primarily by net charge-offs of legacy loans from the acquisition of Pacific Mercantile Bank. The provision for credit losses was $1.9 million for the second quarter and included a $1.7 million provision for loan losses and a $1.0 million provision for credit loss for AFS securities, partially offset by an $0.8 million reversal of the provision for credit losses related to lower unfunded commitments.

Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

The provision for credit losses was $5.0 million for the third quarter and related entirely to the provision for loan losses, which was driven primarily by net charge-offs of legacy loans from the acquisition of Pacific Mercantile Bank. There was no provision for credit losses for the same 2022 period as the $0.5 million provision for loan losses was offset by a $0.5 million reversal of the provision for credit losses related to lower unfunded commitments.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

During the nine months ended September 30, 2023, the provision for credit losses was $8.9 million and included a $9.2 million provision for loan losses and a $1.0 million provision for credit loss for AFS securities, partially offset by a $1.3 million reversal of the provision for credit losses related to lower unfunded commitments. The provision for credit losses was a reversal of $31.5 million during the nine months ended September 30, 2022, and included a $31.3 million recovery from the settlement of a loan previously charged-off in 2019.

See further discussion in "Allowance for Credit Losses."

Noninterest Income

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

($ in thousands)

67

Three Months Ended September 30, 2023 Compared to Three Months Ended June 30, 2023

Noninterest income increased $44.8 million to $50.8 million for the third quarter primarily due to a $46.2 million mark-to-market gain recognized on derivative instruments, partially offset by a $1.7 million decrease in income from equity investments. Concurrently with the announcement of the proposed merger with PacWest, we entered into an aggregate of $3.1 billion in interest rate swaptions and a contingent loan forward sale agreement on $1.8 billion of the SFR loan portfolio to hedge the interest rate risk component of the change in fair value of our balance sheet in anticipation of the application of purchase accounting upon the closing of the proposed merger transaction with PacWest. These derivatives were marked to market at the end of the period and reflected an increase in value from the changes in market interest rates.

Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

Noninterest income for the third quarter of 2023 increased $45.1 million to $50.8 million compared to the same quarter in 2022 mainly due to a $46.2 million mark-to-market gain recognized on derivative instruments, partially offset by lower income from equity investments of $0.7 million and lower customer service fees of $0.3 million.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Noninterest income for the nine months ended September 30, 2023 increased $45.9 million to $64.7 million compared to the same period in 2022 mainly due to the $46.2 million mark-to-market gain recognized on derivative instruments, higher rental income due to an increase in subleased facilities of $0.9 million, and higher loan servicing income of $0.7 million from higher purchased mortgage servicing asset balances, partially offset by lower customer service fees of $1.4 million and lower income from equity investments of $0.2 million.

Noninterest Expense

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

($ in thousands)

Three Months Ended September 30, 2023 Compared to Three Months Ended June 30, 2023

Noninterest expense increased $7.0 million to $56.2 million for the third quarter compared to the second quarter. The increase was due mainly to acquisition, integration and transaction costs of $9.3 million incurred related to our proposed merger with PacWest, partially offset by lower salaries and employee benefits of $2.5 million.

Three Months Ended September 30, 2023 Compared to Three Months Ended September 30, 2022

Noninterest expense increased $5.2 million to $56.2 million for the third quarter of 2023 from $51.0 million for the comparable 2022 period due mainly to higher acquisition, integration and transaction costs of $7.2 million, partially offset by lower salaries and employee benefits of $2.2 million. Acquisition, integration and transactions costs related to the proposed merger with PacWest were $9.3 million for the three months ended September 30, 2023, compared to $2.1 million related to the acquisition of Deepstack for the three months ended September 30, 2022.

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Noninterest expense for the nine months ended September 30, 2023 increased $10.4 million to $156.5 million compared to the same period in 2022. The increase was mainly due to higher (i) acquisition, integration and transaction costs of $7.2 million, (ii) software and technology expense of $1.6 million related to investments in technology infrastructure, (iii) regulatory assessments of $1.2 million as the FDIC increased assessment rates in 2023, (iv) marketing and other expenses of $1.0 million, and (v) professional fees of $0.9 million, including a $0.4 million increase in indemnified legal fees (net of insurance recoveries), partially offset by lower salaries and employee benefits of $1.5 million. Acquisition, integration and transactions costs related to the proposed merger with PacWest were $9.3 million for the nine months ended September 30, 2023, compared to $2.1 million related to the acquisition of Deepstack for the nine months ended September 30, 2022.

Income Tax Expense

For the three months ended September 30, 2023, June 30, 2023 and September 30, 2022, income tax expense was $16.3 million, $6.7 million, and $9.9 million resulting in an effective tax rate of 27.6%, 27.4% and 29.1%.

Income tax expense totaled $30.4 million for the nine months ended September 30, 2023, representing an effective tax rate of 27.4%, compared to $38.9 million and an effective tax rate of 28.1% for the nine months ended September 30, 2022.

For additional information, see Note 8 to Consolidated Financial Statements included in Part I of this Quarterly Report on Form 10-Q.

FINANCIAL CONDITION

Investment Securities

The primary goal of our investment securities portfolio is to provide a relatively stable source of interest income while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk, and interest rate risk. Certain investment securities can be pledged as collateral to obtain public deposits or to provide a secondary source of liquidity in the form of secured borrowings from the FHLB, the FRB, or other financial institutions for repurchase agreements.

Investment Securities Available-for-Sale

The following table presents the amortized cost and fair value of the AFS securities portfolio and the corresponding amounts of unrealized gains and losses recognized in AOCI as of the dates indicated:

($ in thousands)

(1) There was no ACL related to AFS securities at December 31, 2022.

AFS securities were $915.1 million at September 30, 2023, an increase of $46.8 million, or 5.4%, from $868.3 million at December 31, 2022. The increase was mainly due to purchases of $101.7 million, partly offset by principal payments of $23.5 million, calls of $20.0 million, an increase in net unrealized losses of $10.7 million, and a $1.0 million provision for credit losses for corporate debt securities of other financial institutions due to downgrades in their ratings.

Net unrealized losses on AFS securities were $51.9 million at September 30, 2023, compared to $41.3 million at December 31, 2022. The net unrealized losses on AFS securities, net of tax, are reflected in accumulated other comprehensive income (loss). The increases in net unrealized losses during the nine months ended September 30, 2023 were due to wider credit spreads within corporate debt securities and the impact of higher market interest rates on agency CMOs and non-agency residential MBS, which was partly offset by improvement in the valuation of CLOs.

CLOs totaled $483.8 million and $476.6 million and were all AAA and AA-rated at September 30, 2023 and December 31, 2022. We perform due diligence and ongoing credit quality review of our CLO holdings, which includes monitoring performance factors such as external credit ratings, collateralization levels, collateral concentration levels, and other performance factors.

During the three and nine months ended September 30, 2023, we recorded zero and $1.0 million provision for credit losses on three corporate debt securities of other financial institutions that were downgraded to below investment grade by external credit agencies. ACL on investments securities was $1.0 million at September 30, 2023 and there was no ACL required on investment securities at December 31, 2022.

We monitor our securities portfolio to ensure it has adequate credit support and consider the lowest credit rating for identification of potential credit impairment. Except for the corporate debt securities noted above, we believe there was no other credit impairment, and the decline in fair value of our securities since acquisition was attributable to a combination of changes in interest rates and general volatility in market conditions. As of September 30, 2023, we did not have the intent to sell securities in an unrealized loss position and further believe it is more likely than not that we will not be required to sell these securities before their anticipated recovery. Except for the corporate debt securities noted above, as of September 30, 2023, all of our investment securities in an unrealized loss position received an investment grade credit rating.

Investment Securities Held-to-Maturity

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

($ in thousands)

HTM securities totaled $328.3 million at September 30, 2023, compared to $328.6 million at December 31, 2022. At September 30, 2023, HTM securities included $214.1 million in agency securities and $114.2 million in municipal securities.

During the first quarter of 2022, certain longer-duration fixed-rate MBS and municipal securities with an amortized cost basis of $346.0 million were transferred from the AFS portfolio to the HTM portfolio. At the time of the transfer, the securities had an unrealized gross loss of $16.6 million, which became part of the securities’ amortized cost basis. This amount, along with the unrealized loss included in AOCI, is subsequently amortized over the remaining life of the security as an adjustment to its yield using the interest method. As a result, there is no impact on the consolidated statements of operations.

As of September 30, 2023 and December 31, 2022, HTM securities had aggregate unrealized net losses of $78.0 million and $66.2 million, of which $15.0 million and $15.8 million related to unrealized losses from the transfer of certain fixed-rate MBS and municipal securities from the AFS portfolio to the HTM portfolio in the prior year. These unrealized losses related primarily to changes in overall interest rates.

The following table presents the fair values and weighted average yields using amortized cost of the AFS securities portfolio as of September 30, 2023, based on the earlier of contractual maturity dates or next repricing dates:

($ in thousands)

The following table presents the amortized cost and weighted average yields using amortized cost of the HTM securities portfolio as of September 30, 2023, based on the earlier of contractual maturity dates or next repricing dates:

($ in thousands)

71

Loans Receivable, Net

The following table presents the composition of our loan and lease portfolio as of the dates indicated:

($ in thousands)

(1) Includes warehouse lending balances of $647.7 million and $602.5 million at September 30, 2023 and December 31, 2022.

(2) $102.3 million of owner-occupied CRE loans were moved to the C&I category from the CRE category during the third quarter of 2023.

(3) Total loans include net deferred loan origination costs (fees), purchased premiums (discounts), and fair value allocations of premiums (discounts) totaling $7.1 million and $7.1 million at September 30, 2023 and December 31, 2022.

Total loans ended the third quarter of 2023 at $6.96 billion, down $154.0 million from $7.12 billion at December 31, 2022, comprised primarily of a $17.4 million decrease in our commercial portfolio and a $136.6 million decrease in our consumer portfolio.

During the nine months ended September 30, 2023, the decrease in the total loan portfolio was due to changes in the macroeconomic environment, including increases in interest rates impacting new loan volume. During the nine months ended September 30, 2023, we reclassified $102.3 million of owner-occupied CRE loans to the C&I category to appropriately classify these loans according to their purpose and source of repayment. The overall decrease in the commercial portfolio included (i) a decrease in other C&I loans of $52.0 million, partially offset by a $45.2 million increase in warehouse lending balances, (ii) a $35.7 million decrease in multifamily loans driven by payoff activity and (iii) a $11.3 million decrease in SBA loans, partially offset by (iv) a $19.2 million increase in construction loans and (v) a $17.2 million increase in CRE loans.

The decrease in our consumer portfolio was due primarily to a $138.2 million decrease in SFR loans mostly driven by payoffs and paydowns.

Loan fundings of $970.7 million during the nine months ended September 30, 2023 included net warehouse advances of $48.3 million, offset by other loan paydowns and payoffs of $1.11 billion.

Loan concentrations were well-diversified between products and industries. Notably, the CRE portfolio of $1.17 billion had balances related to office loans of $327.6 million, which was 4.7% of total loans. This portfolio was comprised of general office loans of $256.5 million with a weighted average loan-to-value (“LTV”) of 53% and debt service coverage ratio of 1.6x and medical office loans of $71.2 million with a weighted average LTV of 53% and debt service coverage ratio of 1.3x.

In connection with our proposed merger with PacWest, we entered into a contingent loan forward sale agreement on our SFR loan portfolio of $1.8 billion. The contingent forward loan sale agreement was entered to reduce volatility related to the potential sale proceeds by determining a fixed price to be settled on a future date contingent upon completion of the proposed merger. At September 30, 2023, we continue to classify the SFR portfolio as held-for-investment as the sale agreement is contingent upon receipt of approval to close the bank merger. Should the merger not close for any reason, we intend to continue to hold the SFR portfolio for investment.

Credit Quality Indicators

We categorize loans into risk categories based on relevant information about the ability of borrowers to repay their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze the associated risks in the current loan portfolio and individually grade each loan for credit risk. This analysis includes all loans delinquent over 60 days and non-homogeneous loans such as commercial and CRE loans.

The following table presents the risk categories for total loans by class of loans as of September 30, 2023 and December 31, 2022:

($ in thousands)

($ in thousands)

During the nine months ended September 30, 2023, total criticized and classified assets decreased $19.1 million to $164.1 million at September 30, 2023 from decreases in special mention and substandard loans, offset by an increase in doubtful loans.

Total classified assets, consisting of loans risk rated substandard, doubtful and loss, decreased $15.8 million to $103.2 million at September 30, 2023. The decrease was due mostly to payoffs and paydowns of $66.1 million, charge-offs of $11.7 million, and upgrades of $3.5 million, partially offset by downgrades of $65.5 million. At September 30, 2023, loans risk rated doubtful related to three C&I and three SBA relationships, compared to one C&I relationship at December 31, 2022.

Total criticized assets, consisting of loans risk rated special mention, decreased $3.2 million to $60.9 million at September 30, 2023 compared to $64.2 million at December 31, 2022 due mostly to upgrades of $32.1 million, payoffs and paydowns of $16.0 million, partially offset by downgrades of $44.9 million.

Nonperforming Assets

The following table presents a summary of total nonperforming assets, excluding loans held-for-sale, as of the dates indicated:

($ in thousands)

Loans are generally placed on nonaccrual status when they become 90 days past due, unless management believes the loan is well secured and in the process of collection. Past due loans may or may not be adequately collateralized, but collection efforts are continuously pursued. Loans may be restructured by management when a borrower experiences changes to their financial condition, causing an inability to meet the original repayment terms, and where we believe the borrower will eventually overcome those circumstances and repay the loan in full.

Additional interest income of approximately $1.0 million and $2.8 million would have been recorded during the three and nine months ended September 30, 2023, had these loans been paid in accordance with their original terms throughout the periods indicated.

At September 30, 2023, non-performing loans were $60.6 million, and included $39.8 million of SFR loans, $9.7 million of C&I loans, $7.6 million of SBA loans, $1.9 million of CRE loans and $1.1 million of multifamily loans. During the nine months ended September 30, 2023, non-performing loans increased $5.3 million due to total additions of $42.1 million, offset by $20.7 million in charge-offs, $13.2 million in amortization and other removals, and $2.8 million in loans returning to accrual status. Excluding SFR loans, which are well-secured with low weighted average LTV of 57%, non-performing loans decreased $13.4 million from year-end. At September 30, 2023, there were $7.1 million of non-performing loans, primarily consisting of SFR loans that were in a current payment status, however are considered nonaccrual based on other criteria.

At September 30, 2023, non-performing assets included $0.9 million of real estate owned, consisting of one single-family residence we acquired in the second quarter.

Modifications to Borrowers Experiencing Financial Difficulty (effective January 1, 2023 upon adoption of ASU 2022-02)

During the three and nine months ended September 30, 2023, we had 3 and 6 loan modifications made to borrowers experiencing financial difficulty, with an aggregate balance of $7.7 million at September 30, 2023, of which one C&I loan of $3.9 million was previously classified as a TDR. At September 30, 2023, $4.2 million of the $7.7 million in modified loans made to borrowers experiencing financial difficulty were past due.

Troubled Debt Restructurings (for modifications to borrowers experiencing financial difficulty prior to January 1, 2023)

At September 30, 2023 and December 31, 2022, we had 7 and 15 loans classified as TDRs, with an aggregate balance of $3.5 million and $16.1 million. During the nine months ended September 30, 2023 a $3.9 million C&I loan that was restructured during 2022 was modified and accounted for as a new loan. Additionally, $7.8 million relating to three commercial relationships were paid down and $1.2 million were charged off during this same period.

Accruing TDRs were $0.1 million and nonaccrual TDRs were $3.4 million at September 30, 2023, compared to accruing TDRs of $2.7 million and nonaccrual TDRs of $13.4 million at December 31, 2022.

Allowance for Credit Losses - Loans

The ACL, which includes the reserve for unfunded loan commitments, totaled $78.4 million, or 1.13% of total loans, at September 30, 2023, compared to $91.3 million, or 1.28% of total loans, at December 31, 2022. The $12.9 million decrease in the ACL was due to: (i) $13.5 million related to changes in portfolio mix including lower loan balances, charge-off activity, and changes to certain assumptions used in the model, and (ii) $1.3 million lower RUC from lower unfunded commitments, partially offset by (iii) higher specific reserves of $1.9 million. YTD net charge offs totaled $20.7 million and ALL provision expense was $9.2 million. The ACL coverage of non-performing loans was 129% at September 30, 2023 compared to 165% at December 31, 2022.

The following table provides a summary of components of the ACL and related ratios as of the dates indicated:

($ in thousands)

The following tables provide summaries of activity in the ACL for the periods indicated:

($ in thousands)

($ in thousands)

75

The following table presents a summary of net (charge-offs) recoveries and the annualized ratio of net (charge-offs) recoveries to average loans by loan class for the periods indicated:

($ in thousands)

Net charge-offs were $11.5 million during the third quarter of 2023, compared to $0.8 million during the comparable 2022 period. The increase in net charge-offs in the third quarter of 2023 were mainly due to charge-offs within the C&I and SBA portfolio.

($ in thousands)

Net charge-offs were $20.7 million during the nine months ended September 30, 2023, compared to net recoveries of $32.2 million during the comparable 2022 period. The increase in net charge-offs between periods were due to charge-offs in the C&I portfolio in 2023, and the comparable 2022 period including a $31.3 million recovery from the settlement of a loan previously charged-off in 2019.

The following table presents a summary of the allocation of the ALL by loan category as well as loans receivable for each category as of the dates indicated:

($ in thousands)

Servicing Rights

We have retained servicing rights from certain sales of SFR and SBA loans and purchased mortgage servicing rights from unrelated third parties. Purchased mortgage servicing rights are recorded at the purchase price at the time of acquisition, which approximates the fair value. Subsequent to acquisition, we account for these servicing rights using the amortization method. We utilize a subservicer to service all of the loans underlying the purchased mortgage servicing rights. Loans underlying retained and purchased servicing rights are not included in our consolidated statements of financial condition.

Mortgage servicing rights totaled $20.4 million and $22.5 million at September 30, 2023 and December 31, 2022, which are included in other assets in the accompanying consolidated statements of financial condition. We purchased $22.7 million of SFR mortgage servicing rights, with underlying mortgage balances of $1.73 billion, during the second quarter of 2022. At September 30, 2023, the carrying value of these purchased servicing rights was $19.6 million and the unpaid principal balance of the loans underlying these purchased servicing rights was $1.59 billion.

During the three and nine months ended September 30, 2023, we recognized loan servicing income of $0.6 million and $1.7 million. During the three and nine months ended September 30, 2022, we recognized loan servicing income of $0.6 million and $1.0 million.

Alternative Energy Partnerships

We invest in certain alternative energy partnerships (limited liability companies) formed to provide sustainable energy projects that are designed to generate a return primarily through the realization of federal tax credits (energy tax credits) and other tax benefits. These investments help promote the development of renewable energy sources and lower the cost of housing for residents by lowering homeowners’ monthly utility costs.

The following table presents the activity related to our investment in alternative energy partnerships for the three and nine months ended September 30, 2023 and 2022:

($ in thousands)

77

During the three ended September 30, 2023 and 2022, we received a return of capital of $0.3 million and $0.6 million. During the nine months ended September 30, 2023 and 2022, we received a return of capital of $1.1 million and $1.8 million. We did not make any capital contributions during the periods indicated.

During the three months ended September 30, 2023 and 2022, we recognized a net gain on investment of $34 thousand and a net loss on investment of $0.5 million. During the nine months ended September 30, 2023 and 2022, we recognized net losses on investment of $1.5 million and $1.7 million. From an income tax benefits perspective, we recognized no investment tax credits during these periods; however, we recorded income tax expense of $10 thousand and income tax benefits of $0.1 million related to these investments for the three months ended September 30, 2023 and 2022 and income tax benefits of $0.4 million and $0.5 million during the nine months ended September 30, 2023 and 2022.

For additional information, see Note 12 to Consolidated Financial Statements (unaudited) included in Part I of this Quarterly Report on Form 10-Q.

Deposits

The following table shows the composition of deposits by type as of the dates indicated:

($ in thousands)

Total deposits were $6.64 billion at September 30, 2023, a decrease of $480.3 million, or 6.7%, from $7.12 billion at December 31, 2022 due to lower noninterest-bearing checking balances of $442.8 million, lower interest-bearing demand deposits of $415.9 million, and lower savings and money market balances of $17.8 million, partially offset by higher certificates of deposits of $396.2 million.

We continue to focus on growing granular relationship-based deposits and strategically replacing short-term wholesale funding as we actively manage our funding costs. Noninterest-bearing deposits totaled $2.37 billion and represented 36% of total deposits at September 30, 2023, compared to $2.81 billion and 39% at December 31, 2022.

Brokered deposits were $1.03 billion and $614.9 million at September 30, 2023 and December 31, 2022. During the nine months ended September 30, 2023, we added short-term brokered deposits to increase our liquidity due to the operating environment during this period.

As of September 30, 2023, insured deposits of $4.57 billion and collateralized deposits of $312.5 million represented 74% of total deposits, compared to insured deposits of $3.93 billion and collateralized deposits of $341.6 million, or 60% of total deposits at December 31, 2022.

The following table presents the scheduled maturities of certificates of deposit as of September 30, 2023:

($ in thousands)

78

Borrowings

We have various available lines of credit. These include the ability to borrow funds from time to time on a long-term, short-term, or overnight basis from the FHLB, the FRB, or other financial institutions. The following table presents our borrowings as of the dates indicated:

($ in thousands)

In light of market volatility in the first half of 2023, we proactively performed liquidity-enhancing measures, including additional advances from the FHLB and draws on available FRB facilities. We reduced our excess liquidity toward the end of the second quarter as market volatility began to stabilize.

FHLB Advances. FHLB advances are collateralized by a blanket lien on all real estate loans. At September 30, 2023, our secured borrowing capacity with the FHLB totaled $2.42 billion, of which the Bank was eligible to borrow an additional $1.19 billion based on qualifying loans with an aggregate unpaid principal balance of $3.63 billion as of that date.

As of September 30, 2023, FHLB advances increased $81.0 million, or 11.1%, to $808.3 million mainly due to an increase in term putable advances of $100.0 million, partially offset by decrease in overnight advances of $20.0 million.

FRB Borrowings. At September 30, 2023, the Bank had borrowing capacity with the Federal Reserve of $1.38 billion, including the secured borrowing capacity through the FRB Discount Window, BIC and BTFP programs. The FRB credit programs are collateralized by certain qualifying loans with an unpaid principal balance of $1.28 billion and securities with a carrying value of $505.8 million.

We utilized available capacity in the FRB Discount Window and BIC programs through $200.0 million in overnight borrowings, but did not utilize the BTFP and there was no outstanding borrowing under this program at September 30, 2023.

Other Borrowings. The Bank maintains available unsecured federal funds lines with six correspondent banks totaling $290.0 million and $210.0 million, with no outstanding borrowings at September 30, 2023 and December 31, 2022.

We mainly utilize FHLB and FRB borrowings and the unsecured federal funds lines as our secondary source of funds. From time to time, the Bank may also utilize alternate sources of funds, including unsecured overnight borrowings through AFX and other financial institutions. The availability of such unsecured borrowings fluctuates regularly and are subject to the counterparties discretion. Other borrowings from these alternate sources totaled $185.8 million and zero under these facilities at September 30, 2023 and December 31, 2022.

In addition, the holding company maintains a $50.0 million revolving line of credit, with no borrowings under this line of credit at September 30, 2023 and December 31, 2022.

For additional information, see Note 6 - Federal Home Loan Bank Advances, Federal Reserve Bank Borrowings and Other Borrowings of the Notes to Consolidated Financial Statements (unaudited) included in Part I of this Quarterly Report on Form 10-Q.

Long-term Debt

The following table presents our long-term debt as of the dates indicated:

($ in thousands)

(1) The Senior Notes bear interest at a fixed rate of 5.25% per annum, payable semi-annually in arrears.

(2) The Subordinated Notes bear interest at an initial fixed rate of 4.375% per annum, payable semi-annually in arrears. From and including October 30, 2025 to, but excluding, the maturity date or the date of earlier redemption, the Subordinated Notes bear interest at a floating rate per annum equal to a benchmark rate, which is expected to be 3-Month Term SOFR, plus a spread of 419.5 basis points, payable quarterly in arrears.

During the three months ended September 30, 2023, there were no repurchases of senior notes. During the nine months ended September 30, 2023, we repurchased senior notes with an outstanding balance of $1.0 million at a discount and recognized an $80 thousand gain. There were no repurchases of senior notes during the three and nine months ended September 30, 2022.

At September 30, 2023, we were in compliance with all covenants under our long-term debt agreements.

Liquidity Management

We are required to maintain sufficient liquidity to ensure a safe and sound operation. Liquidity may increase or decrease depending upon availability of funds and comparative yields on investments in relation to the return on loans. Historically, we have maintained liquid assets above levels believed to be adequate to meet the requirements of normal operations, including both expected and unexpected cash flow needs such as funding loan commitments, potential deposit outflows and dividend payments. Cash flow projections are regularly reviewed and updated to ensure that adequate liquidity is maintained. We also monitor our liquidity requirements in light of rising interest rate trends, changes in the economy and scheduled maturity and interest rate sensitivity of our investment and loan portfolio and deposits.

Post-closing of the merger, we expect to manage liquidity in a similar fashion as our current management framework, but will adopt new liquidity management policies that address the fact that we will be a larger institution with new product lines, including deposits in business lines not existing for us today. In doing so, we will assess the new characteristics associated with the combined company when establishing oversight of key metrics, along with other critical “Liquidity,” “Funding,” and “Investment” tolerances.

Banc of California, N.A.

Primary Sources of Liquidity: The Bank’s liquidity, represented by cash and cash equivalents and AFS securities, is a product of its operating, investing, and financing activities. The Bank’s primary sources of funds are deposits, payments and maturities of outstanding loans and investment securities; sales of loans, investment securities, and other short-term investments; and funds provided from operations. While scheduled payments and maturities of loans, investment securities and other short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition.

At September 30, 2023, we had primary liquidity of $1.00 billion, including total cash and cash equivalents of $311.0 million and unpledged AFS securities of $717.7 million. Our cash increased $82.1 million from December 31, 2022 and $27.3 million from June 30, 2023 as we continued to reduce the excess liquidity that we deployed in the first quarter of 2023 as part of a conservative strategy to hold extra liquidity due to the operating environment during this period.

Secondary Sources of Liquidity: The Bank also generates cash through secured and unsecured secondary sources of funds. The Bank maintains pre-established secured lines of credit with the FHLB and the FRB as secondary sources of liquidity to provide funds for lending and investment activities and to enhance interest rate risk and liquidity risk management. At September 30, 2023, we had available unused secured borrowing capacities of $1.19 billion from the FHLB and $1.18 billion through the FRB Discount Window, BIC and BTFP programs.

The Bank has additional sources of secondary liquidity through pre-established unsecured federal funds lines with correspondent banks totaling $290.0 million, with no outstanding borrowings at September 30, 2023.

We mainly utilize FHLB and FRB borrowings and the unsecured federal funds lines as our secondary source of funds. From time to time, the Bank may also utilize alternate sources of funds, including unsecured overnight borrowings through AFX and other financial institutions. The availability of such unsecured borrowings fluctuates regularly and are subject to the counterparties discretion. Other borrowings from these alternate sources totaled $185.8 million and zero under these facilities at September 30, 2023 and December 31, 2022.

As of September 30, 2023, the Company had high levels of liquidity available with total cash and cash equivalents of $311.0 million, unpledged AFS securities of $717.7 million, and unused borrowing capacity of $2.67 billion, resulting in total primary and secondary liquidity available of $3.67 billion. This was 2.1 times total uninsured and uncollateralized deposits of $1.76 billion.

Banc of California, Inc.

Primary Sources of Liquidity: The primary sources of funds for Banc of California, Inc., on a stand-alone holding company basis, are dividends and intercompany tax payments from the Bank, outside borrowing, and its ability to raise capital and issue debt securities. Dividends from the Bank are largely dependent upon the Bank’s earnings and are subject to restrictions under certain regulations that limit its ability to transfer funds to the holding company. OCC regulations impose various restrictions on the ability of a bank to make capital distributions, which include dividends, stock redemptions or repurchases, and certain other items. Generally, a well-capitalized bank may make capital distributions during any calendar year equal to up to 100 percent of year-to-date net income plus retained net income for the two preceding years without prior OCC approval. However, any dividend paid by the Bank would be limited by the need to maintain its well-capitalized status plus the capital buffer in order to avoid additional dividend restrictions (Refer to Capital - Dividend Restrictions below for additional information). Currently, the Bank does not have sufficient dividend-paying capacity to declare and pay such dividends to the holding company without obtaining prior approval from the OCC under the applicable regulations. During the three and nine months ended September 30, 2023, the Bank paid zero and $70.0 million of dividends to Banc of California, Inc. At September 30, 2023, Banc of California, Inc. had $44.1 million in cash, all of which was on deposit at the Bank.

Secondary Sources of Liquidity: In addition, the holding company has a $50.0 million revolving line of credit. There were no borrowings under this line of credit at September 30, 2023 and at December 31, 2022, and we were in compliance with all covenants.

On February 13, 2023, we announced our Board of Directors authorized the repurchase of up to $35 million of our common stock. The repurchase authorization expires in February 2024. Purchases may be made in open-market transactions, in block transactions on or off an exchange, in privately negotiated transactions or by other means as determined by our management and in accordance with the regulations of the SEC. The timing of purchases and the number of shares repurchased under the program will depend on a variety of factors including price, trading volume, corporate and regulatory requirements and market conditions.

During the three months ended September 30, 2023, there were no shares of common stock repurchased under the program. During the nine months ended September 30, 2023, there were 1,759,491 shares of common stock repurchased under the program at a weighted average price of $12.02. As of September 30, 2023, the Company had $13.9 million remaining under the current stock repurchase authorization.

Commitments and Contractual Obligations

The following table presents our commitments and contractual obligations as of September 30, 2023:

($ in thousands)

At September 30, 2023, we had unfunded commitments of $15.4 million, $7.4 million, and $20.5 million for LIHTC investments, SBIC investments, and other investments. Unfunded commitments for LIHTC investments were included in accrued expenses and other liabilities on the consolidated balance sheet.

Capital

In order to maintain adequate levels of capital, we continuously assess projected sources and uses of capital to support projected asset growth, operating needs and credit risk. We consider, among other things, earnings generated from operations and access to capital from financial markets. In addition, we perform capital stress tests on an annual basis to assess the impact of adverse changes in the economy on our capital base. Increases in market interest rates resulted in higher net unrealized losses in our securities portfolio and stockholders’ equity. As market interest rates increase, bond prices tend to fall and, consequently, the fair value of our securities may also decrease. To this end, we may have further net unrealized losses on our securities classified as available–for-sale, which would negatively affect our total and tangible stockholders’ equity.

Regulatory Capital

The Company and the Bank are subject to the regulatory capital adequacy guidelines that are established by the Federal banking regulators. Under the relevant rules and including the required conservation buffer, common equity Tier 1 capital, Tier 1 risk-based capital and total risk-based capital ratio minimums are 7.0%, 8.5% and 10.5%.

The following table presents the regulatory capital amounts and ratios for the Company and the Bank as of dates indicated:

82

Dividend Restrictions

Payment of dividends by the Company are subject to guidance provided by the Federal Reserve. That guidance provides that bank holding companies that plan to pay dividends that exceed net earnings for a given period should first consult with the Federal Reserve. To the extent future quarterly dividends exceed quarterly net earnings, payment of dividends in respect of the Company’s common stock will be subject to prior consultation and non-objection from the Federal Reserve.

Our principal source of funds for dividend payments is dividends received from the Bank. Federal banking laws and regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, in the case of the Bank, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. Accordingly, any dividend granted by the Bank would be limited by the need to maintain its well capitalized status plus the capital buffer in order to avoid additional dividend restrictions. As described above, currently the Bank cannot pay dividends to us without OCC approval. During the three and nine months ended September 30, 2023, the Bank paid zero and $70.0 million in dividends to Banc of California, Inc.

During the three and nine months ended September 30, 2023, we declared and paid dividends on our common stock of $0.10 and $0.30 per share totaling $5.7 million and $17.2 million.

Post-closing of the merger, the surviving bank, as a California state-chartered bank and member of the Federal Reserve System, will be subject to applicable California and federal law and regulations, including any approval requirements with respect to dividends paid by the surviving bank.

Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.

How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we have established asset/liability committees to monitor our interest rate risk. In monitoring interest rate risk we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities and/or prepayments, and their sensitivity to actual or potential changes in market interest rates.

We maintain both a management asset/liability committee (“Management ALCO”), comprised of select members of senior management, and a joint asset/liability committee of the Boards of Directors of the Company and the Bank (“Board ALCO”, together with Management ALCO, “ALCOs”). In order to manage the risk of potential adverse effects of material and prolonged or volatile changes in interest rates on our results of operations, we have adopted asset/liability management policies to align maturities and repricing terms of interest-earning assets to interest-bearing liabilities. The asset/liability management policies establish guidelines for the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs, while management monitors adherence to those guidelines with oversight by the ALCOs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk, and profitability goals. The ALCOs meet no less than quarterly to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections pursuant to our economic value of equity analysis.

In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we evaluate various strategies including:

• Complementing our current loan origination platform through strategic acquisitions of whole loans,
• Strategically managing multiple warehouse relationships,
• Originating shorter-term consumer loans,
• Managing the level of investments and duration of investment securities,
• Managing our deposits to establish stable deposit relationships, and
• Using FHLB advances and/or certain derivatives such as swaps as hedges to align maturities and repricing terms.

At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the ALCOs may decide to increase our interest rate risk position within the asset/liability tolerance set forth by our Board of Directors. As part of its procedures, the ALCOs regularly review interest rate risk by forecasting the impact of alternative interest rate environments on net interest income and our economic value of equity.

Interest Rate Sensitivity of Economic Value of Equity and Net Interest Income

Interest rate risk results from our banking activities and is the primary market risk for us. Interest rate risk is caused by the following factors:

• Repricing risk - timing differences in the repricing and maturity of interest-earning assets and interest-bearing liabilities;
• Option risk - changes in the expected maturities of assets and liabilities, such as borrowers’ ability to prepay loans and depositors’ ability to redeem certificates of deposit before maturity;
• Yield curve risk - changes in the yield curve where interest rates increase or decrease in a nonparallel fashion; and
• Basis risk - changes in spread relationships between different yield curves, such as U.S. Treasuries, U.S. Prime Rate, SOFR and London Interbank Offered Rate.

Since our earnings are primarily dependent on our ability to generate net interest income, we focus on actively monitoring and managing the effects of adverse changes in interest rates on our net interest income. Management of our interest rate risk is overseen by the Board ALCO, which delegates the day to day management of interest rate risk to the Management ALCO. Management ALCO ensures that the Bank is following the appropriate and current regulatory guidance in the formulation and implementation of our interest rate risk program. Board ALCO reviews the results of our interest rate risk modeling quarterly to ensure that we have appropriately measured our interest rate risk, mitigated our exposures appropriately and any residual risk is acceptable. In addition to our annual review of our asset liability management policy, our Board of Directors periodically reviews the interest rate risk policy limits.

Interest rate risk management is an active process that encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic repricing characteristics of our assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.

Our interest rate risk exposure is measured and monitored through various risk management tools, including a simulation model that performs interest rate sensitivity analysis under multiple scenarios. The simulation model is based on the actual maturities and re-pricing characteristics of the Bank’s interest-rate sensitive assets and liabilities. The simulated interest rate scenarios include an instantaneous parallel shift in the yield curve (“Rate Shock”). We then evaluate the simulation results using two approaches: Net Interest Income at Risk (“NII at Risk”), and Economic Value of Equity (“EVE”). Under NII at Risk, the impact on net interest income from changes in interest rates on interest-earning assets and interest-bearing liabilities is modeled utilizing various assumptions for assets, liabilities, and derivatives.

EVE measures the period end present value of assets minus the present value of liabilities. Asset liability management uses this value to measure the changes in the economic value of the Company under various interest rate scenarios. In some ways, the economic value approach provides a broader scope than net income volatility approach since it captures all anticipated cash flows.

The balance sheet is considered “asset sensitive” when an increase in short-term interest rates is expected to expand our net interest income, as rates earned on our interest-earning assets reprice higher at a pace faster than rates paid on our interest-bearing liabilities. Conversely, the balance sheet is considered “liability sensitive” when an increase in short-term interest rates is expected to compress our net interest income, as rates paid on our interest-bearing liabilities reprice higher at a pace faster than rates earned on our interest-earning assets.

At September 30, 2023, our interest rate risk profile is “asset sensitive”, as compared to a “neutral” interest rate risk profile position as of June 30, 2023 and December 31, 2022 mainly due to the impact of the interest rate swaptions executed in connection with the proposed merger (see below). Given the uncertainty of the magnitude, timing and direction of future interest rate movements, as well as the shape of the yield curve, actual results may vary materially from those predicted by our model.

The following table presents the projected change in the Company’s economic value of equity at September 30, 2023 and net interest income over the next twelve months, that would occur upon an immediate change in interest rates, but without giving effect to any steps that management might take to counteract that change:

($ in thousands)

(1) Assumes an instantaneous uniform change in interest rates at all maturities and no rate shock has a rate lower than zero percent.

Use of Derivatives to Manage Interest Rate Risk Related to the Proposed Merger with PacWest

Concurrently with the announcement of the proposed bank merger, we entered into an aggregate $3.1 billion of interest rate swaptions, where, if executed, we would pay a fixed rate and receive a floating rate based on 2-year, 7-year and 10-year SOFR. We entered into these swaptions to protect against rising interest rate risk associated with various assets on our balance sheet in anticipation of the sale of such assets in connection with the proposed merger with PacWest. These swaptions were included in our simulation model to project change in the Company’s economic value of equity at September 30, 2023 and net interest income over the next twelve months and provide a material benefit on the economic value of equity and net interest income in the upward shock rate scenarios until their expiration on November 28, 2023.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates of deposit could deviate significantly from those assumed in calculating the table.

Evaluation of Disclosure Controls and Procedures

An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Act) as of September 30, 2023 was carried out under the supervision and with the participation of the Company’s Principal Executive Officer, Principal Financial Officer and other members of the Company’s senior management. The Company’s Principal Executive Officer and Principal Financial Officer concluded that, as of September 30, 2023, the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company’s management (including the Principal Executive Officer and Principal Financial Officer) to allow timely decisions regarding required disclosure; and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Act) that occurred during the nine months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all errors and fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of a control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

There have been no material changes to the risk factors that appeared under Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022 and in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2023.