PCB Bancorp: Form 10-Q for the period ended Sep 30, 2024

The following is management’s discussion and analysis of the major factors that influenced the Company’s results of operations and financial condition as of and for the three and nine months ended September 30, 2024. This analysis should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 and with the unaudited consolidated financial statements and notes (unaudited) thereto set forth in this Quarterly Report on Form 10-Q.

Critical Accounting Estimates

The Company’s consolidated financial statements are prepared in accordance with GAAP and general practices within the banking industry. Within these financial statements, certain financial information contains approximate measurements of financial effects of transactions and impacts at the consolidated statements of financial condition dates and the Company’s results of operations for the reporting periods. As certain accounting policies require significant estimates and assumptions that have a material impact on the carrying value of assets and liabilities, the Company has established critical accounting policies to facilitate making the judgment necessary to prepare financial statements. The Company’s critical accounting policies are described in Note 1 to Consolidated Financial Statements and in the “Critical Accounting Estimates” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in its Annual Report on Form 10-K for the year ended December 31, 2023 and in Note 1 to Consolidated Financial Statements (unaudited) included in Part I of this Quarterly Report on Form 10-Q.

Allowance for Credit Losses

On January 1, 2023, the Company adopted the provisions of ASC 326, “Financial Instruments - Credit Losses (Topic 326)” Instruments. The adoption of ASC 326 changes the way the Company estimates the ACL on certain financial assets. The adoption of ASC 326 requires the Company to measure and record current expected credit losses for financial assets within the scope of ASC 326, which the Company currently consist substantially of loans, off-balance sheet credit exposures and securities available-for-sale. Measuring credit losses under the current expected credit losses (“CECL”) framework requires a significant amount of judgment, including the incorporation of reasonable and supportable forecasts about future conditions that may ultimately impact the level of credit losses the Company may recognize. Under the CECL framework, current expected credit losses are recorded on financial assets within the scope of ASC 326 at the time of their origination or acquisition.

Estimating expected credit losses requires management to use relevant forward-looking information, including the use of reasonable and supportable forecasts. The measurement of the ACL is performed by collectively evaluating loans with similar risk characteristics. The Company’s discounted cash flow methodology incorporates a probability of default and loss given default model, as well as expectations of future economic conditions, using reasonable and supportable forecasts.

The use of reasonable and supportable forecasts requires significant judgment, such as selecting forecast scenarios, as well as determining the appropriate length of the forecast horizon. Management leverages economic projections from a reputable and independent third party to inform and provide its reasonable and supportable economic forecasts. Although no one economic variable can fully demonstrate the sensitivity of the ACL estimate to changes in economic variables used in the ACL model, the Company utilized changes in U.S. unemployment rate and year-over-year change in real gross domestic product (“GDP”) growth rate as its key economic variables. Other internal and external indicators of economic forecasts may also be considered by management when developing the forecast metrics. The Company’s ACL model reverts to long-term average loss rates for purposes of estimating expected cash flows beyond a period deemed reasonable and supportable. The Company forecasts economic conditions and expected credit losses over a one-year time horizon. Beyond the one-year forecast time horizon, the Company’s ACL model reverts to historical long-term average loss rates over a one-year period.

Within the various economic scenarios considered as of September 30, 2024, the quantitative estimate of the ACL would increase by approximately $8.4 million under sole consideration of a more adverse downside scenario. The quoted sensitivity calculation reflects the sensitivity of the modeled ACL estimate to macroeconomic forecast data, but is absent of qualitative overlays and other qualitative adjustments that are part of the quarterly reserving process and does not necessarily reflect the nature and extent of future changes in the ACL for reasons including increases or decreases in qualitative adjustments, changes in the risk profile and size of the portfolio, changes in the severity of the macroeconomic scenario and the range of scenarios under management consideration.

A portion of the collectively evaluated ACL on loans also includes qualitative adjustments for risk factors not reflected or captured by the quantitative modeled ACL but are relevant in estimating future expected credit losses. Qualitative adjustments may be related to and include, but not limited to factors such as: (i) management’s assessment of economic forecasts used in the model and how those forecasts align with management’s overall evaluation of current and expected economic conditions, (ii) organization-specific risks such as credit concentrations, collateral specific risks, regulatory risks, and external factors that may ultimately impact credit quality, (iii) potential model limitations such as limitations identified through back-testing, and other limitations associated with factors such as underwriting changes, acquisition of new portfolios and changes in portfolio segmentation, and (iv) management’s overall assessment of the adequacy of the ACL, including an assessment of ACL model data inputs.

Although management uses the best information reasonably available to derive estimates and assumptions necessary to measure an appropriate level of the ACL, these estimates and assumptions are subject to change in future periods, which may have a material impact on the level of the ACL and the Company’s results of operations.

Non-GAAP Measures

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

The following tables present reconciliation of return on average tangible common equity, tangible common equity per common share and tangible common equity to tangible assets ratios to their most comparable GAAP measures as of the dates or for the periods indicated. These non-GAAP measures, which are presented in this Quarterly Report on Form 10-Q, are used by management in its analysis of the Company's performance.

($ in thousands)

($ in thousands, except per share data)

42

Selected Financial Data

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

($ in thousands, except per share data)

43

($ in thousands, except per share data)

(1) Shareholders’ equity divided by common shares outstanding.

(2) Annualized.

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

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

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

(6) Total loans include both loans held-for-sale and loans held-for-investment.

(7) Nonperforming loans include nonaccrual loans and loans past due 90 days or more and still accruing.

(8) Nonperforming assets include nonperforming loans and other real estate owned.

(9) Non-GAAP measure. See "Non-GAAP Measures" for a reconciliation to its most comparable GAAP measure.

Executive Summary

Q3 2024 Financial Highlights

• Net income available for common shareholders was $7.5 million for the three months ended September 30, 2024, an increase of $445 thousand, or 6.3%, from $7.0 million for the three months ended September 30, 2023;
• Recorded a provision for credit losses of $50 thousand for the three months ended September 30, 2024 compared with $751 thousand for the three months ended September 30, 2023.
• ACL on loan to loans held-for-investment ratio was 1.17% at September 30, 2024 compared with 1.19% at December 31, 2023.
• Net interest income was $22.7 million for the three months ended September 30, 2024 compared with $22.4 million for the three months ended September 30, 2023. Net interest margin was 3.25% for the three months ended September 30, 2024 compared with 3.57% for the three months ended September 30, 2023.
• Gain on sale of loans was $750 thousand for the three months ended September 30, 2024 compared with $689 thousand for the three months ended September 30, 2023.
• Total assets were $2.89 billion at September 30, 2024, an increase of $100.3 million, or 3.6%, from $2.79 billion at December 31, 2023;
• Loans held-for-investment were $2.47 billion at September 30, 2024, an increase of $142.7 million, or 6.1%, from $2.32 billion at December 31, 2023; and
• Total deposits were $2.46 billion at September 30, 2024, an increase of $108.1 million, or 4.6%, from $2.35 billion at December 31, 2023.

Results of Operations

Net Interest Income

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

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 periods indicated:

($ in thousands)

(1) Average balance includes both loans held-for-sale and loans held-for-investment, as well as nonaccrual loans. Net amortization of deferred loan fees of $246 thousand and $226 thousand, respectively, and net accretion of discount on loans of $773 thousand and $775 thousand, respectively, are included in the interest income for the three months ended September 30, 2024 and 2023.

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

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

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

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

(6) Annualized.

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 periods indicated:

($ in thousands)

(1) Average balance includes both loans held-for-sale and loans held-for-investment, as well as nonaccrual loans. Net amortization of deferred loan fees of $919 thousand and $648 thousand, respectively, and net accretion of discount on loans of $2.1 million and $2.2 million, respectively, are included in the interest income for the nine months ended September 30, 2024 and 2023.

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

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

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

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

(6) Annualized.

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

($ in thousands)

Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023

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

($ in thousands)

Net interest income increased primarily due to an 11.4% increase in average balance of interest-earning assets and a 40 basis point increase in average yield, partially offset by a 22.2% increase in average balance of interest-bearing liabilities and a 68 basis point increase in average cost.

Interest and fees on loans increased primarily due to a 14.9% increase in average balance and a 39 basis point increase in average yield. The increase in average yield was primarily due to increases in overall interest rates on loans and net amortization of deferred loan fees.

Interest on investment securities increased primarily due to a 39 basis point increase in average yield and a 6.1% increase in average balance. The increase in average yield was primarily due to a higher yield on newly purchased investment securities. For the three months ended September 30, 2024 and 2023, the average yield on total investment securities was 3.73% and 3.34%, respectively.

Interest income on other interest-earning assets increased primarily due to a 17 basis point increase in average yield, partially offset by a 19.8% decrease in average balance. The increase in average yield was primarily due to an increase in dividends received on FHLB stock. For the three months ended September 30, 2024 and 2023, the average yield on total other interest-earning assets was 5.66% and 5.49%, respectively.

Interest expense on deposits increased primarily due to a 21.2% increase in average balance of interest-bearing deposits and an 68 basis point increase in average cost of interest-bearing deposits. The increase in average balance was primarily due to the migration of noninterest-bearing deposits to money market accounts and time deposits attributable to the rising market rates. The increase in average cost was primarily due to an increase in market rates. For the three months ended September 30, 2024 and 2023, average cost on total interest-bearing deposits was 4.85% and 4.17%, respectively, and average cost on total deposits were 3.78% and 2.97%, respectively.

The Company did not utilize borrowings during the three months ended September 30, 2023.

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

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

($ in thousands)

Net interest income decreased primarily due to a 26.0% increase in average balance of interest-bearing liabilities and a 98 basis point increase in average cost, partially offset by a 12.6% increase in average balance of interest-earning assets and a 50 basis point increase in average yield.

Interest and fees on loans increased primarily due to a 14.8% increase in average balance and a 46 basis point increase in average yield. The increase in average yield was primarily due to increases in overall interest rates on loans and net amortization of deferred loan fees.

Interest on investment securities increased primarily due to a 44 basis point increase in average yield and a 1.6% increase in average balance. The increase in average yield was primarily due to a decrease in net amortization of premiums on securities and a higher yield on newly purchased investment securities. For the nine months ended September 30, 2024 and 2023, the average yield on total investment securities was 3.67% and 3.23%, respectively.

Interest income on other interest-earning assets increased primarily due to a 51 basis point increase in average yield, partially offset by a 2.3% decrease in average balance. The increase in average yield was primarily due to an increase in interest rate on cash held at the Federal Reserve Bank and dividends received on FHLB stock. For the nine months ended September 30, 2024 and 2023, the average yield on total other interest-earning assets was 5.67% and 5.16%, respectively.

Interest expense on deposits increased primarily due to a 24.0% increase in average balance of interest-bearing deposits and a 98 basis point increase in average cost of interest-bearing deposits. The increase in average balance was primarily due to the migration of noninterest-bearing deposits to money market accounts and time deposits attributable to the rising market rates. The increase in average cost was primarily due to an increase in market rates. For the nine months ended September 30, 2024 and 2023, average cost on total interest-bearing deposits was 4.85% and 3.87%, respectively, and average cost on total deposits were 3.76% and 2.70%, respectively.

Interest expense on borrowings increased primarily due to a 579.7% increase in average balance and a 24 basis point increase in average cost of interest-bearing deposits. The increase in average cost was primarily due to an increase in market rates.

Provision (reversal) for Credit Losses

The following tables present a composition of provision (reversal) for credit losses for the periods indicated:

($ in thousands)

($ in thousands)

The provision for credit losses for the three and nine months ended September 30, 2024 was primarily due to increases in loans held-for-investment and quantitatively measured loss reserve requirement, partially offset by a decrease in reserve related to qualitative adjustment factors. See further discussion in “Allowance for Credit Losses.”

Noninterest Income

Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023

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

($ in thousands)

Loan servicing income decreased primarily due to a decrease in servicing fee income and an increase in servicing asset amortization. Servicing asset amortization was $478 thousand and $470 thousand, respectively, for the three months ended September 30, 2024 and 2023.

Gain on sale of loans increased primarily due to an increase in level of premium on SBA loans in the secondary market, partially offset by a decrease in sales volume. The Company sold SBA loans of $13.5 million with a gain of $750 thousand and a residential mortgage loan of $676 thousand at par during the three months ended September 30, 2024. During the three months ended September 30, 2023, the Company sold SBA loans of $17.7 million with a gain of $689 thousand.

Other income primarily included wire transfer fees of $156 thousand and $162 thousand, respectively, and debit card interchange fees of $154 thousand and $103 thousand, respectively, for the three months ended September 30, 2024 and 2023.

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

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

($ in thousands)

Loan servicing income decreased primarily due to a decrease in servicing fee income and an increase in servicing asset amortization. Servicing asset amortization was $1.4 million and $1.3 million, respectively, for the nine months ended September 30, 2024 and 2023.

Gain on sale of loans decreased primarily due to an increase in level of premium on SBA loans in the secondary market, partially offset by a decrease in sales volume. The Company sold SBA loans of $46.5 million with a gain of $2.6 million and a residential mortgage loan of $676 thousand at par during the nine months ended September 30, 2024. During the nine months ended September 30, 2023, the Company sold SBA loans of $61.6 million with a gain of $2.8 million.

Other income primarily included wire transfer fees of $462 thousand and $467 thousand, respectively, and debit card interchange fees of $253 thousand and $254 thousand, respectively, for the nine months ended September 30, 2024 and 2023.

Noninterest Expense

Three Months Ended September 30, 2024 Compared to Three Months Ended September 30, 2023

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

($ in thousands)

Salaries and employee benefits increased primarily due to increases in salaries, bonus accrual, incentives tied to sales of SBA loans originated at LPOs, and other employee benefits, partially offset by a decrease in vacation accrual. The number of full-time equivalent employees was 264 at September 30, 2024 compared to 270 at September 30, 2023.

Occupancy and equipment increased primarily due to an expansion of headquarters location in the second half of 2023, the relocation of a regional office and the consolidation of two branches into a new location in Orange County, California starting from the three months ended June 30, 2024.

Professional fees decreased primarily due to the completion a core system conversion that was completed in April 2024, resulting in high professional fees during the three months ended September 30, 2024.

Marketing and business promotion expense decreased primarily due to a decrease in advertisements.

Regulatory assessments increased primarily due to an increase in the balance sheet.

Other expenses included $97 thousand and $114 thousand in loan related expenses, $625 thousand and $565 thousand in office expense, and $221 thousand and $206 thousand in armed guard expense for the three months ended September 30, 2024 and 2023, respectively.

Nine Months Ended September 30, 2024 Compared to Nine Months Ended September 30, 2023

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

($ in thousands)

Salaries and employee benefits increased primarily due to salaries, bonus accrual, incentives tied to sales of SBA loans originated at LPOs, and other employee benefits, partially offset by a decrease in vacation accrual. The number of full-time equivalent employees was 264 at September 30, 2024 compared to 270 at September 30, 2023.

Occupancy and equipment increased primarily due to an expansion of headquarters location in the second half of 2023, and the relocation of a regional office and the consolidation of two branches into a new location in Orange County, California starting from the three months ended June 30, 2024.

Professional fees decreased primarily due to the completion a core system conversion that was completed in April 2024, resulting in high professional fees during the nine months ended September 30, 2024.

Marketing and business promotion expense decreased primarily due to a decrease in advertisements.

Regulatory assessments increased primarily due to an increase in the balance sheet.

Other expenses included $315 thousand and $311 thousand in loan related expenses, $1.7 million and $1.6 million in office expense, and $635 thousand and $588 thousand in armed guard expense for the nine months ended September 30, 2024 and 2023, respectively. In addition, the Company recognized a termination charge for the legacy core system of $508 thousand and an expense of $815 thousand for a reimbursement for an SBA loan guarantee previously paid by the SBA on a loan originated in 2014 that subsequently defaulted and was ultimately determined to be ineligible for the SBA guaranty during the nine months ended September 30, 2024.

Income Tax Expense

Income tax expense was $2.9 million and $3.0 million, respectively, and the effective tax rate was 26.9% and 29.7%, respectively, for the three months ended September 30, 2024 and 2023. For nine months ended September 30, 2024 and 2023, income tax expense was $7.2 million and $10.2 million, respectively, and the effective tax rate was 27.7% and 29.2%, respectively.

Financial Condition

Investment Securities

The Company’s investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit risk. The types and maturities of securities purchased are primarily based on current and projected liquidity and interest rate sensitivity positions.

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

($ in thousands)

Total investment securities were $147.6 million at September 30, 2024, an increase of $4.3 million, or 3.0%, from $143.3 million at December 31, 2023. The increase was primarily due to purchases of $14.8 million and an increase in fair value of securities available-for-sale of $3.5 million, partially offset by principal paydowns of $13.9 million and net premium amortization of $123 thousand.

As of September 30, 2024, 95.3%, at amortized cost basis, of the Company's securities available-for-sale were issued by U.S. government agency and U.S. government sponsored enterprise. Because the decline in fair value is attributable to changes in interest rates, and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell these securities before their anticipated recovery, the Company determined that these securities with unrealized losses did not warrant an ACL.

Municipal and corporate bonds had an investment grade rating upon purchase. The issuers of these securities have not established any cause for default on these securities and various rating agencies have reaffirmed their long-term investment grade status as of September 30, 2024. These securities have fluctuated in value since their purchase dates as market interest rates fluctuated. Additionally, the Company continues to receive contractual principal and interest payments in a timely manner. The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell before the recovery of its amortized cost basis. The Company determined that the investment securities with unrealized losses did not warrant an ACL as of September 30, 2024.

As of September 30, 2024, the Company recorded no ACL on securities available-for-sale.

The following table presents the contractual maturity schedule for securities, at amortized cost, and their weighted-average yields as of the date indicated:

($ in thousands)

Weighted-average yields are based upon the amortized cost of securities and are calculated using the interest method which takes into consideration of premium amortization and discount accretion. Weighted-average yields on tax-exempt debt securities exclude the federal income tax benefit.

Loans Held-For-Sale

Loans held-for-sale are carried at the lower of cost or fair value. When a determination is made at the time of commitment to originate as held-for-investment, it is the Company’s intent to hold these loans to maturity or for the foreseeable future, subject to periodic reviews under the Company’s management evaluation processes, including asset/liability management and credit risk management. When the Company subsequently changes its intent to hold certain loans, the loans are transferred to held-for-sale at the lower of cost or fair value. Certain loans are transferred to held-for-sale with write-downs to allowance for credit losses on loans.

Loans held-for-sale were $5.2 million at September 30, 2024, an increase of $15 thousand, or 0.3%, from $5.2 million at December 31, 2023. The increase was primarily due to new funding of $48.3 million and a loan transferred from loan held-for-investment of $676 thousand, partially offset by sales of $47.2 million and pay-offs and pay-downs of $1.8 million.

Loans Held-For-Investment and Allowance for Credit Losses

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

($ in thousands)

Loans held-for-investment were $2.47 billion at September 30, 2024, an increase of $142.7 million, or 6.1%, from $2.32 billion at December 31, 2023. The increase was primarily due to new funding and advances of $1.83 billion, partially offset by paydowns and payoffs of $1.69 billion.

The following table presents activities in ACL for the periods indicated:

($ in thousands)

The increase in ACL for the three months ended September 30, 2024 was primarily due to increases in loans held-for-investment and quantitatively measured loss reserve requirement, partially offset by a decrease in reserve related to qualitative adjustment factors. The increase in the quantitatively measured loss reserve requirement was primarily due to the increased unemployment rate forecasts by the Federal Open Market Committee (“FOMC”). The projected 2024 and 2025 year-end national unemployment rate increased to 4.4% and 4.4%, respectively, in the September 2024 meeting from 4.0% and 4.2%, respectively, in the June 2024 meetings, which resulted an increase in probability of default (“PD”) rates for the 4-quarter projected period. The projected 2024 year-end year-over-year change in real GDP decreased to 2.0% in the September 2024 meeting from 2.1% in the June 2024 meetings. The projected 2025 year-end year-over-year change in real GDP was maintained at 2.0% at both meetings. Management believes that the projections used are reasonable and aligns with the Company’s expectation of the economic environment over the next 4 quarters.

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

($ in thousands)

57

Nonperforming Loans and Nonperforming Assets

The following table presents a summary of total non-performing assets as of the dates indicated:

($ in thousands)

The increase in nonaccrual loans held-for-investment was primarily due to loans placed on nonaccrual status of $6.6 million, partially offset by paydowns and payoffs of $1.6 million, loans returned to accrual status of $2.0 million, charge-offs of $126 thousand, and a loan transferred to OREO of $94 thousand during the nine months ended September 30, 2024.

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. In all cases, loans are placed on nonaccrual if collection of principal or interest is considered doubtful. 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 management believes the borrower will eventually overcome those circumstances and repay the loan in full. Additional income of approximately $171 thousand and $432 thousand would have been recorded during the three and nine months ended September 30, 2024, respectively, had these loans been paid in accordance with their original terms throughout the periods indicated.

Deposits

The Bank gathers deposits primarily through its branch locations. The Bank offers a variety of deposit products including demand deposits accounts, NOW and money market accounts, savings accounts and time deposits. The following table presents a summary of the Company’s deposits as of the dates indicated:

($ in thousands)

The decrease in noninterest-bearing demand deposits was primarily due to strong deposit market competition and the migration of noninterest-bearing demand deposits to interest-bearing deposits. To retain existing and attract new customers, the Bank offers competitive rates on deposit products.

The increase in retail time deposits was primarily due to new accounts of $272.7 million and renewals of the matured accounts of $560.4 million, partially offset by matured and closed accounts of $760.8 million.

As of September 30, 2024 and December 31, 2023, total deposits were comprised of 22.0% and 25.3%, respectively, of noninterest-bearing demand accounts, 20.0% and 17.9%, respectively, of savings, NOW and money market accounts, and 58.0% and 56.8%, respectively, of time deposits.

Deposits from certain officers, directors and their related interests with which they are associated held by the Company were $3.3 million and $3.7 million, respectively, at September 30, 2024 and December 31, 2023.

The following table presents the maturity of time deposits as of the dates indicated:

($ in thousands)

59

Shareholders’ Equity and Regulatory Capital

Capital Resources

Shareholders’ equity is influenced primarily by earnings, dividends paid on common stock and preferred stock, sales and redemptions of common stock and preferred stock, and changes in accumulated other comprehensive income caused primarily by fluctuations in unrealized gains or losses, net of taxes, on securities available-for-sale.

Shareholders’ equity was $362.3 million at September 30, 2024, an increase of $13.4 million, or 3.8%, from $348.9 million at December 31, 2023. The increase was primarily due to net income of $18.8 million and a decrease in accumulated other comprehensive loss of $2.5 million, partially offset by dividends declared on common stock of $7.7 million, repurchases of common stock of $222 thousand and preferred stock dividends of $488 thousand.

Regulatory Capital Requirements

The Bank is subject to various regulatory capital requirements administered by the federal and state banking regulators. The Company is not currently subject to separate minimum capital requirements under the Federal Reserve’s “Small Bank Holding Company” policy. At such time as the Company reaches the $3 billion asset level, it will be subject to consolidated capital requirements independent of the Bank.

Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for the prompt corrective action (“PCA”), the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies. In addition to these uniform risk-based capital guidelines and leverage ratios that apply across the industry, the regulators have the discretion to set individual minimum capital requirements for specific institutions at rates significantly above the minimum guidelines and ratios.

The following table presents a summary of the capital requirements applicable to the Bank in order to be considered “well-capitalized” from a regulatory perspective, as well as the Bank’s capital ratios as of the dates indicated. For comparison purpose, the Company’s ratios are included as well, all of which would have exceeded the “well-capitalized” level under PCA had the Company been subject to separate capital minimums.

To avoid restrictions on dividends, share repurchases and discretionary compensation payments to executives, the federal banking agencies require a banking organization to maintain a capital conservation buffer of 2.50% in common tier 1 capital, in addition to the minimum capital ratios necessary to minimum regulatory requirements. The capital conservation buffer increases the minimum common equity Tier 1 capital ratio to 7%, the minimum Tier 1 capital (to risk-weighted assets) ratio to 8.5% and the minimum total capital ratio (to risk-weighted assets) to 10.5% for banking organizations seeking to avoid the limitations on dividends, share repurchases and discretionary compensation payments to executives. The Company’s and the Bank’s capital conservation buffer were 7.42% and 7.54%, respectively, as of September 30, 2024, and 7.73% and 8.07%, respectively, as of December 31, 2023.

Emergency Capital Investment Program

On May 24, 2022, the Company issued 69,141 shares of Series C Preferred Stock for the capital investment of $69.1 million from the U.S. Treasury under the ECIP. The ECIP investment qualifies as tier 1 capital for purposes of the bank regulatory capital requirements.

The Series C Preferred Stock accrued no dividend for the first 24 months following the investment date. Beginning on May 24, 2024, holders of the Series C Preferred Stock are entitled to quarterly non-cumulative cash dividends as declared by the Company’s Board of Directors. The Series C Preferred Stock dividend rate adjusts annually based on the lending growth criteria listed in the terms of the ECIP investment with the annual dividend rate up to 2%. After the tenth anniversary of the investment date, the dividend rate will be fixed based on average annual amount of lending in years 2 through 10. Dividends will be payable quarterly in arrears on March 15, June 15, September 15, and December 15. The terms of the Series C Preferred Stock prohibit the Company from paying dividends on or repurchasing shares of its common stock unless it has paid or contemporaneously pays the full Series C Preferred Stock dividend with respect to the preceding quarterly dividend period.

The Series C Preferred Stock may be redeemed at the option of the Company on or after the fifth anniversary of issuance (or earlier in the event of loss of regulatory capital treatment), subject to the approval of the appropriate federal banking regulator and in accordance with the federal banking agencies’ regulatory capital regulations.

Established by the Consolidated Appropriations Act of 2021, the ECIP was created to encourage low- and moderate-income community financial institutions and minority depository institutions to provide loans, grants, and forbearance for small businesses, minority-owned businesses, and consumers, especially low-income and underserved communities, including persistent poverty counties, that may be disproportionately impacted by the economic effect of the COVID-19 pandemic by providing direct and indirect capital investments in low- and moderate-income community financial institutions.

The Company began paying quarterly dividends on the Series C Preferred Stock at 2% beginning in the three months ended June 30, 2024. Dividends on the Series C Preferred Stock totaled $346 thousand and $488 thousand for the three and nine months ended September 30, 2024, respectively.

Stock Repurchases

During the year ended December 31, 2023, the Company repurchased and retired 512,657 shares of common stock at a weighted-average price of $17.22 per share under a stock repurchase program approved by the Board of Directors on August 2, 2023 and a legacy stock repurchase program approved on July 28, 2022.

During the nine months ended September 30, 2024, the Company repurchased and retired 14,947 shares of common stock at a weighted-average price of $14.88 per share. On July 25, 2024, the Company announced the amendment of the 2023 stock repurchase program, which extended the program expiration from August 2, 2024 to August 1, 2025. As of September 30, 2024, the Company was authorized to purchase 577,777 additional shares under the 2023 stock repurchase program.

Liquidity

Liquidity refers to the measure of ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting operating cash flow and capital and strategic cash flow needs, all at a reasonable cost. The Company continuously monitors its liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of the Company’s shareholders.

The Company’s liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest-bearing deposits in financial institutions, federal funds sold, and unpledged securities available-for-sale. Liquid liabilities may include core deposits, federal funds purchased, securities sold under repurchase agreements and other borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market non-core deposits, additional collateralized borrowings such as FHLB advances and Federal Reserve Discount Window, and the issuance of debt securities and preferred or common securities.

The Company’s short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of prepaying and maturing balances in loan and investment securities portfolios, increases in debt financing and other borrowings, and increases in customer deposits.

Integral to the Company’s liquidity management is the administration of borrowings. To the extent the Company is unable to obtain sufficient liquidity through core deposits, the Company seeks to meet its liquidity needs through wholesale funding or other borrowings on either a short or long-term basis.

The following table presents a summary of the Company’s liquidity position as of the dates indicated:

($ in thousands)

The Company also maintains relationships in the capital markets with brokers and dealers to issue time deposits and money market accounts.

PCB Bancorp, on a stand-alone holding company basis, must provide for its own liquidity and its main source of funding is dividends from the Bank. There are statutory, regulatory and debt covenant limitations that affect the ability of the Bank to pay dividends to the holding company. Management believes that these limitations will not impact the Company’s ability to meet its ongoing short- and long-term cash obligations.

Off-Balance Credit Exposures and Contractual Obligations

Off-Balance Sheet Credit Exposures

The Company has limited off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on financial condition, results of operations, liquidity, capital expenditures or capital resources.

In the ordinary course of business, the Company enters into financial commitments to meet the financing needs of its customers. These financial commitments include commitments to extend credit, unused lines of credit, commercial and similar letters of credit and standby letters of credit. Those instruments involve to varying degrees, elements of credit and interest rate risk not recognized in the Company’s financial statements.

The Company’s exposure to loan loss in the event of nonperformance on these financial commitments is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for loans reflected in the consolidated financial statements.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. The Company evaluates each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary is based on management’s credit evaluation of the customer. The following table presents outstanding financial commitments whose contractual amount represents credit risk as of the dates indicated:

($ in thousands)

Contractual Obligations

The following table presents supplemental information regarding total contractual obligations as of the dates indicated:

($ in thousands)

Management believes that the Company will be able to meet its contractual obligations as they come due through the maintenance of adequate cash levels. Management expects to maintain adequate cash levels through profitability, loan and securities repayment and maturity activity and continued deposit gathering activities. The Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.

Market risk represents the risk of loss due to changes in market values of assets and liabilities. Market risk occurs in the normal course of business through exposures to market interest rates, equity prices, and credit spreads.

Overview

Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (repricing risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and Secured Overnight Financing Rate (“SOFR”) (basis risk).

The Company’s Board Asset Liability Committee (“ALCO”) establishes broad policy limits with respect to interest rate risk. Board ALCO establishes specific operating guidelines within the parameters of the Board of Directors’ policies. In general, the Company seeks to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. Board ALCO meets quarterly to monitor the level of interest rate risk sensitivity to ensure compliance with the Board of Directors’ approved risk limits. The Company also has a Management ALCO, which is comprised of the senior management team and the Chief Executive Officer, to proactively monitor interest rate risk.

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 characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.

An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on interest-earning assets would reprice upward more quickly than rates paid on interest-bearing liabilities, thus expanding net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on interest-bearing liabilities would reprice upward more quickly than rates earned on interest-earning assets, thus compressing net interest margin.

Measurement

Interest rate risk exposure is measured and monitored through various risk management tools, which include a simulation model that performs interest rate sensitivity analyses under multiple interest rate scenarios. Interest rate risk measurement is calculated and reported to the Board ALCO at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.

The Company uses two approaches to model interest rate risk: Net Interest Income at Risk (“NII at Risk”), and Economic Value of Equity (“EVE”). Under NII at Risk, net interest income is modeled utilizing various assumptions for assets, liabilities, and derivatives. The Company uses a static balance sheet to perform these analyses. EVE measures the period end market value of assets minus the market value of liabilities and the change in this value as rates change. EVE simulation reflects the effect of interest rate shifts on the value of the Company. In contrast to NII simulation, EVE simulation identifies risks arising from repricing or maturity gaps over the life of the balance sheet. The EVE approach provides a comparatively broader scope than the NII at Risk approach since it captures all anticipated cash flows.

Simulation results are highly dependent on input assumptions. To the extent the actual behavior is different from the assumption used in the models, there could be material changes in results. The assumptions applied in the model are documented, supported, and periodically back-tested to assess the reasonableness and effectiveness. The Company makes appropriate changes to the model as needed and these changes are reviewed by Board and Management ALCOs. The Company also continuously validates the model, methodology and results. Scenario results do not reflect strategies that the management could employ to limit the impact of changing interest rate expectations.

As part of the Company’s continuous evaluation and periodic enhancements to its NII and EVE calculations. The model incorporates deposit repricing assumptions impacting both consumer and wholesale deposits, deposit behavior assumption related to its non-maturity deposits, and prepayment assumptions related to its loan portfolio. The model modifications incorporated observed pricing and customer behavior in both rising and falling interest rate environments. The model is updated annually and was last evaluated during the three months ended September 30, 2024.

The following table presents the projected changes in NII at Risk and EVE that would occur upon an immediate change in interest rates based on independent analysis as of the dates indicated, but without giving effect to any steps that management might take to counteract changes:

On September 18, 2024, the FOMC lowered the upper range of the Fed Funds Target Rate from 5.5% to 5.0%. In the accompanying statement, they added, “The Committee has gained greater confidence that inflation is moving sustainably toward 2%, and judges that the risks to achieving its employment and inflation goals are roughly in balance.” The Committee added that they remain attentive to the risks to both sides of its dual mandate, and will carefully assess incoming data, the evolving outlook and balance of risks.

As of September 30, 2024, the Company’s net interest income sensitivity results exhibit an asset sensitive profile. Net interest income is expected to increase when interest rates rise, as the Company has a large proportion of variable rate loans in its loan portfolio, primarily linked to Prime Rate indices, that are sensitive to changes in short-term interest rates. The Company’s deposit portfolio is also sensitive to changes in short-term interest rates, even though a large portion of its deposit mix is composed of non-maturity deposits that are not directly tied to short-term interest rate indices. The modeled results are highly sensitive to reinvestment yield and deposit beta assumptions. Actual results in net interest income during a period of rising interest rates may vary from the Company’s net interest income sensitivity results, as the actual result reflects earnings asset growth and deposit mix changes based on customer preferences relative to the interest rate environment.

The Company’s EVE sensitivity reflects a slight liability sensitive profile due to the continuing deposit mix shift from non-maturity deposits to time deposits. The model result is highly sensitive to deposit behaviors as well as loan prepayment assumptions. Due to the uncertainty of the current economic forecast, and timing and direction of future interest rate movements, actual result may vary from the Company’s EVE sensitivity results.

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, 2024 was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and other members of the Company’s senior management. The Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2024, 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 Chief Executive Officer and Chief 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.

Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) under the Exchange Act) during the three months ended September 30, 2024 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management is not aware of any material changes to the risk factors that appeared under “Part I, Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023. In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors discussed in Part 1, Item 1A, of the Annual Report on Form 10-K for the year ended December 31, 2023, which could materially and adversely affect the Company’s business, financial condition, results of operations and stock price. The risks described in this Quarterly Report on Form 10-Q and in the Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not presently known to management or that management presently believes not to be material may also result in material and adverse effects on the Company’s business, financial condition, and results of operations.