Cathay General Bancorp: Form 10-Q for the period ended Mar 31, 2023

The following discussion is based on the assumption that the reader has access to and has read the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

Critical Accounting Policies

The discussion and analysis of the Company’s financial condition and results of operations are based upon its unaudited Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these Consolidated Financial Statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues, and expenses, and related disclosures of contingent assets and liabilities at the date of the Consolidated Financial Statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies involve significant judgments, assumptions and uncertainties and are essential to understanding the Company’s results of operations and financial condition. Management of the Company considers the following to be critical accounting policies:

Accounting for the allowance for loan losses involves significant judgments and assumptions by management, which have a material impact on, among other things, the carrying value of net loans. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances as described in “Allowance for Credit Losses” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in the 2022 Form 10-K. For more information, please also see Note 3 to the Company’s unaudited Consolidated Financial Statements.

Highlights

• Total deposits increased by $143.6 million, or 3.1% annualized, to $18.6 billion in the first quarter of 2023.
• The net interest margin decreased to 3.74% in the first quarter of 2023 from 3.87% in the fourth quarter of 2022.
• Diluted earnings per share decreased to $1.32 in the first quarter 2023 compared to $1.33 for the fourth quarter of 2022.

Quarterly Statement of Operations Review

Net Income

Net income for the quarter ended March 31, 2023, was $96.0 million, an increase of $21.0 million, or 28.0%, compared to net income of $75.0 million for the same quarter a year ago. Diluted earnings per share for the quarter ended March 31, 2023, was $1.32 per share compared to $0.99 per share for the same quarter a year ago.

Return on average stockholders’ equity was 15.39% and return on average assets was 1.76% for the quarter ended March 31, 2023, compared to a return on average stockholders’ equity of 12.29% and a return on average assets of 1.46% for the same quarter a year ago.

Financial Performance

Net Interest Income Before Provision for Credit Losses

Net interest income before provision for credit losses increased $33.2 million, or 20.9%, to $192.4 million during the first quarter of 2023, compared to $159.2 million during the same quarter a year ago. The increase was due primarily to an increase in interest income from loans and securities offset, in part, by an increase in interest expense from deposits.

The net interest margin was 3.74% for the first quarter of 2023 compared to 3.26% for the first quarter of 2022 and 3.87% for the fourth quarter of 2022.

For the first quarter of 2023, the yield on average interest-earning assets was 5.54%, the cost of funds on average interest-bearing liabilities was 2.46%, and the cost of interest-bearing deposits was 2.40%. In comparison, for the first quarter of 2022, the yield on average interest-earning assets was 3.53%, the cost of funds on average interest-bearing liabilities was 0.38%, and the cost of interest-bearing deposits was 0.33%. The increase in the yield on average interest-earning assets resulted mainly from higher interest rates on loans and securities. The net interest spread, defined as the difference between the yield on average interest-earning assets and the cost of funds on average interest-bearing liabilities, was 3.08% for the quarter ended March 31, 2023 compared to 3.15% for the same quarter a year ago.

The following table sets forth information concerning average interest-earning assets, average interest-bearing liabilities, and the average yields and rates paid on those assets and liabilities for the three months ended March 31, 2023, and 2022. Average outstanding amounts included in the table are daily averages.

(In thousands)

(1) Yields and amounts of interest earned include loan fees. Non-accrual loans are included in the average balance.

(2) Calculated by dividing net interest income by average outstanding interest-earning assets.

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The following table summarizes the changes in interest income and interest expense attributable to changes in volume and changes in interest rates for the three months ended March 31, 2023 and 2022:

Taxable-Equivalent Net Interest Income — Changes Due to Volume and Rate(1)

(In thousands)

(1) Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated proportionately to changes due to volume and changes due to rate.

Provision for credit losses

The Company recorded a provision for credit losses of $8.1 million in the first quarter of 2023 compared with $1.4 million in the fourth quarter of 2022 and $8.6 million in the first quarter of 2022. As of March 31, 2023, the allowance for credit losses, comprised of the reserve for loan losses and the reserve for unfunded loan commitments, increased $3.3 million to $158.5 million, or 0.87% of gross loans, compared to $155.2 million, or 0.85% of gross loans, as of December 31, 2022. The change in the allowance for credit losses during the first quarter of 2023 consisted of an $8.1 million provision for credit losses, and $4.9 million in net charge-offs.

The following table sets forth the charge-offs and recoveries for the periods indicated:

(In thousands)

(1) Real estate loans include commercial mortgage loans, residential mortgage loans, and equity lines.

Non-Interest Income

Non-interest income, which includes revenues from depository service fees, letters of credit commissions, securities gains (losses), wealth management fees, and other sources of fee income, was $14.2 million for the first quarter of 2023, a decrease of $6.0 million, or 29.7%, compared to $20.2 million for the first quarter of 2022. The decrease was primarily due to a $3.0 million write-off of an available for sale security from Signature Bank, a decrease of $1.4 million in swap dealer fees, and a decrease of $1.0 million in unrealized gains on equity securities, when compared to the same quarter a year ago.

Non-Interest Expense

Non-interest expense increased $10.5 million, or 14.4%, to $83.2 million in the first quarter of 2023 compared to $72.7 million in the same quarter a year ago. The increase in non-interest expense in the first quarter of 2023 was primarily due to an increase of $7.3 million in amortization expense of investments in low-income housing and alternative energy partnerships, an increase of $2.8 million in salaries and employee benefits, an increase of $1.4 million in FDIC deposit insurance assessment expense, and an increase of $1.3 million in computer and equipment expense offset, in part, by a decrease of $3.9 million in acquisition, integration and restructuring costs, when compared to the same quarter a year ago. The efficiency ratio, defined as non-interest expense divided by the sum of net interest income before provision for loan losses plus non-interest income, was 40.3% in the first quarter of 2023 compared to 40.5% for the same quarter a year ago.

Income Taxes

The effective tax rate for the first quarter of 2023 was 16.8% compared to 23.5% for the first quarter of 2022. The effective tax rate includes the impact of alternative energy investments and low-income housing tax credits.

Balance Sheet Review

Assets

Total assets were $22.03 billion as of March 31, 2023 an increase of $0.08 billion or 0.4% from $21.95 billion as of December 31, 2022.

Securities Available-for-Sale

Effective January 1, 2021, upon the adoption of ASU 2016-13, Financial Instruments - Credit Losses, debt securities available-for-sale are measured at fair value and subject to impairment testing. When an available-for-sale debt security is considered impaired, the Company must determine if the decline in fair value has resulted from a credit-related loss or other factors and then, (1) recognize an allowance for credit losses by a charge to earnings for the credit-related component (if any) of the decline in fair value, and (2) recognize in other comprehensive income (loss) any non-credit related components of the fair value change. If the amount of the amortized cost basis expected to be recovered increases in a future period, the valuation reserve would be reduced, but not more than the amount of the current existing reserve for that security.

For available-for-sale (“AFS”) debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value. For AFS debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors with the credit component of the unrealized loss of the impaired AFS debt security recognized as an allowance for credit losses, and a corresponding provision for credit losses on the consolidated statement of income.

In making this assessment, management considers the extent to which fair value is less than amortized cost, the payment structure of the security, failure of the issuer of the security to make scheduled interest or principal payments, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. Any fair value changes that have not been recorded through an allowance for credit losses is recognized in other comprehensive income.

Losses are charged against the allowance when management believes the uncollectability of an AFS debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Changes in the allowance for credit losses are recorded as provision for credit loss expense.

The amortized cost of the Company’s AFS debt securities exclude accrued interest, which is included in “accrued interest income” on the Consolidated Balance Sheets. The Company has made an accounting policy election not to measure an allowance for credit losses for accrued interest receivables on AFS debt securities since the Company timely reverses any previously accrued interest when the debt security remains in default for an extended period. As each AFS debt security has a unique security structure, where the accrual status is clearly determined when certain criteria listed in the terms are met, the Company assesses the default status of each security as defined by the debt security’s specific security structure. At March 31, 2023, no AFS debt securities were in default.

In the current period, management evaluated the securities in an unrealized loss position and determined that their unrealized losses were a result of the level of market interest rates relative to the types of securities and pricing changes caused by shifting supply and demand dynamics and not a result of downgraded credit ratings or other indicators of deterioration of the underlying issuers' ability to repay. Accordingly, we determined the unrealized losses were not credit-related and recognized the unrealized losses in "other comprehensive income" in stockholders' equity. Although we periodically sell securities for portfolio management purposes, we do not foresee having to sell any impaired securities strictly for liquidity needs and believe that it is more likely than not we would not be required to sell any impaired securities before recovery of their amortized cost.

Securities available-for-sale represented 7.0% of total assets as of March 31, 2023, compared to 6.7% of total assets as of December 31, 2022. Securities available-for-sale were $1.54 billion as of March 31, 2023, compared to $1.47 billion as of December 31, 2022.

The following tables set forth the amortized cost, gross unrealized gains, gross unrealized losses, and fair value of securities available-for-sale as of March 31, 2023, and December 31, 2022:

(In thousands)

(In thousands)

For additional information, see Note 8 to the Company’s unaudited Consolidated Financial Statements.

Securities available-for-sale having a carrying value of $144.0 million as of March 31, 2023, and $145.7 million as of December 31, 2022, were pledged to secure public deposits and other borrowings.

Equity Securities

The Company recognized a net gain of $4.9 million for the three months ended March 31, 2023, due to the increase in fair value of equity investments with readily determinable fair values compared to a net gain of $6.0 million for the three months ended March 31, 2022. Equity securities were $27.0 million and $22.2 million as of March 31, 2023, and December 31, 2022, respectively.

Loans

Gross loans were $18.32 billion at March 31, 2023, an increase of $63.3 million, or 0.3%, from $18.25 billion at December 31, 2022. The increase was primarily due to an increase of $131.3 million, or 2.5%, in residential mortgage loans and an increase of $123.1 million, or 1.4% in commercial mortgage loans offset, in part, by a decrease of $165.7 million, or 5.0%, in commercial loans, and a decrease of $25.9 million, or 8.0% in home equity loans.

The loan balances and composition at March 31, 2023, compared to December 31, 2022, are set forth below:

(in thousands)

Non-performing Assets

Non-performing assets include loans past due 90 days or more and still accruing interest, non-accrual loans, and OREO. Our policy is to place loans on non-accrual status if interest and/or principal is past due 90 days or more, or in cases where management deems the full collection of principal and interest unlikely. After a loan is placed on non-accrual status, any previously accrued but unpaid interest is reversed and charged against current income and subsequent payments received are generally first applied towards the outstanding principal balance of the loan. Depending on the circumstances, management may elect to continue the accrual of interest on certain past due loans if partial payment is received and/or the loan is well collateralized and in the process of collection. The loan is generally returned to accrual status when the borrower has brought the past due principal and interest payments current and, in the opinion of management, the borrower has demonstrated the ability to make future payments of principal and interest as scheduled.

Management reviews the loan portfolio regularly to seek to identify problem loans. During the ordinary course of business, management may become aware of borrowers that may not be able to meet the contractual requirements of their loan agreements. Such loans generally are placed under closer supervision with consideration given to placing the loans on non-accrual status, the need for an additional allowance for loan losses, and (if appropriate) partial or full charge-off.

The ratio of non-performing assets to total assets was 0.4% as of March 31, 2023, compared to 0.4% as of December 31, 2022. Total non-performing assets increased $5.9 million, or 7.0%, to $90.4 million as March 31, 2023, compared to $84.5 million as of December 31, 2022, primarily due to an increase of $4.7 million, or 6.9%, in nonaccrual loans, and an increase of $1.2 million, or 10.2% in accruing loans past due 90 days or more.

As a percentage of gross loans, excluding loans held for sale, plus OREO, our non-performing assets were 0.49% as of March 31, 2023, compared to 0.46% as of December 31, 2022. The non-performing loan portfolio coverage ratio, defined as the allowance for credit losses to non-performing loans, increased to 183.5% as of March 31, 2023, from 193.0% as of December 31, 2022.

The following table sets forth the changes in non-performing assets and TDRs as of March 31, 2023, compared to December 31, 2022, and to March 31, 2022:

(in thousands)

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Non-accrual Loans

As of March 31, 2023, total non-accrual loans were $73.6 million, an increase of $4.7 million, or 6.8%, from $68.9 million at December 31, 2022, and a decrease of $12.7 million, or 14.7%, from $86.3 million at March 31, 2022. The allowance for the collateral-dependent loans is calculated based on the difference between the outstanding loan balance and the value of the collateral as determined by recent appraisals, sales contracts, or other available market price information, less cost to sell. The allowance for collateral-dependent loans varies from loan to loan based on the collateral coverage of the loan at the time of designation as non-performing. We continue to monitor the collateral coverage of these loans, based on recent appraisals, on a quarterly basis and adjust the allowance accordingly.

The following tables set forth the type of properties securing the non-accrual portfolio loans and the type of businesses the borrowers engaged in as of the dates indicated:

(In thousands)

(1) Real estate includes commercial mortgage loans, real estate construction loans, residential mortgage loans, equity lines and installment & other loans.

(In thousands)

(1) Real estate includes commercial mortgage loans, real estate construction loans, residential mortgage loans, equity lines and installment & other loans.

As of March 31, 2023, recorded investment in non-accrual loans was $73.6 million. As of December 31, 2022, recorded investment in non-accrual loans totaled $68.9 million. For non-accrual loans, the amounts previously charged-off represent 10.5% of the contractual balances for non-accrual loans as of March 31, 2023 and 14.1% as of December 31, 2022. As of March 31, 2023, $51.5 million, or 70.0%, of the $73.6 million of non-accrual loans were secured by real estate compared to $43.1 million, or 62.6%, of the $68.9 million of non-accrual loans that were secured by real estate as of December 31, 2022. The Bank generally seeks to obtain current appraisals, sales contracts, or other available market price information intended to provide updated factors in evaluating potential loss.

As of March 31, 2023, $4.3 million of the $144.9 million allowance for loan losses was allocated for non-accrual loans and $140.6 million was allocated to the general allowance.

The allowance for loan losses to non-performing loans was 167.81% as of March 31, 2023, compared to 182.12% as of December 31, 2022, primarily due to an increase in the non-accrual loans. Non-accrual loans also include those TDRs that do not qualify for accrual status.

The following table presents non-accrual loans and the related allowance as of March 31, 2023 and December 31, 2022:

(In thousands)

(In thousands)

Loan Interest Reserves

In accordance with customary banking practice, construction loans and land development loans generally are originated where interest on the loan is disbursed from pre-established interest reserves included in the total original loan commitment. Our construction loans and land development loans generally include optional renewal terms after the maturity of the initial loan term. New appraisals are obtained prior to extension or renewal of these loans in part to determine the appropriate interest reserve to be established for the new loan term. Loans with interest reserves are generally underwritten to the same criteria, including loan to value and, if applicable, pro forma debt service coverage ratios, as loans without interest reserves. Construction loans with interest reserves are monitored on a periodic basis to gauge progress towards completion. Interest reserves are frozen if it is determined that additional draws would result in a loan to value ratio that exceeds policy maximums based on collateral property type. Our policy limits in this regard are consistent with supervisory limits and range from 50% in the case of land to 85% in the case of one to four family residential construction projects.

As of March 31, 2023, construction loans of $374.9 million were disbursed with pre-established interest reserves of $46.2 million, compared to $443.9 million with pre-established interest reserves of $54.5 million at December 31, 2022. The balance for construction loans with interest reserves that have been extended was $17.2 million with pre-established interest reserves of $0.4 million at March 31, 2023, compared to $34.4 million with pre-established interest reserves of $1.0 million at December 31, 2022. Land loans of $44.2 million were disbursed with pre-established interest reserves of $1.2 million at March 31, 2023, compared to $48.6 million of land loans disbursed with pre-established interest reserves of $1.6 million at December 31, 2022. At March 31, 2023 and December 31, 2022, the balance for land loans with interest reserves that have been extended was $0.9 million with pre-established interest reserves of $58 thousand.

At March 31, 2023 and December 31, 2022, the Bank had no loans on non-accrual status with available interest reserves. At March 31, 2023 and December 31, 2022, there were zero non-accrual non-residential construction loans, residential construction loans, and land loans that were originated with pre-established interest reserves. While we typically expect loans with interest reserves to be repaid in full according to the original contractual terms, some loans may require one or more extensions beyond the original maturity before full repayment. Typically, these extensions are required due to construction delays, delays in the sale or lease of the property, or some combination of these two factors.

Loan Concentration

Most of the Company’s business activities are with clients located in the high-density Asian-populated areas of Southern and Northern California; New York City, New York; Dallas and Houston, Texas; Seattle, Washington; Boston, Massachusetts; Chicago, Illinois; Edison, New Jersey; Rockville, Maryland; and Las Vegas, Nevada. The Company also has loan clients in Hong Kong. The Company has no specific industry concentration, and generally our loans are collateralized with real property or other pledged collateral of the borrowers. The Company generally expects loans to be paid off from the operating profits of the borrowers, refinancing by another lender, or through sale by the borrowers of the collateral. There were no loan concentrations to multiple borrowers in similar activities that exceeded 10% of total loans as of March 31, 2023, or as of December 31, 2022.

The federal banking regulatory agencies issued final guidance on December 6, 2006, regarding risk management practices for financial institutions with high or increasing concentrations of commercial real estate (“CRE”) loans on their balance sheets. The regulatory guidance reiterates the need for sound internal risk management practices for those institutions that have experienced rapid growth in CRE lending, have notable exposure to specific types of CRE, or are approaching or exceeding the supervisory criteria used to evaluate the CRE concentration risk, but the guidance is not to be construed as a limit for CRE exposure. The supervisory criteria are: (1) total reported loans for construction, land development, and other land represent 100% of the institution’s total risk-based capital, and (2) both total CRE loans represent 300% or more of the institution’s total risk-based capital and the institution’s CRE loan portfolio has increased 50% or more within the last thirty-six months. The Bank’s loans for construction, land development, and other land represented 26.8% of the Bank’s total risk-based capital as of March 31, 2023, and 27.3% as of December 31, 2022. Total CRE loans represented 288.0% of total risk-based capital as of March 31, 2023, and 287.1% as of December 31, 2022 which were within the Bank’s internal limit of 400%, of total capital.

Allowance for Credit Losses

The Bank maintains the allowance for credit losses at a level that the Bank’s management considers appropriate to cover the estimated and known risks in the loan portfolio and off-balance sheet unfunded credit commitments. Allowance for credit losses is comprised of the allowance for loan losses and for off-balance sheet unfunded credit commitments. With this risk management objective, the Bank’s management has an established monitoring system that is designed to identify individually evaluated and potential problem loans, and to permit periodic evaluation of impairment and the appropriate level of the allowance for credit losses in a timely manner.

In addition, the Company’s Board of Directors has established a written credit policy that includes a credit review and control system that it believes should be effective in ensuring that the Bank maintains an appropriate allowance for credit losses. The Board of Directors provides oversight for the allowance evaluation process, including quarterly evaluations, and determines whether the allowance is appropriate to absorb losses in the credit portfolio. The determination of the amount of the allowance for credit losses and the provision for credit losses are based on management’s current judgment about the credit quality of the loan portfolio and take into consideration known relevant internal and external factors that affect collectability when determining the appropriate level for the allowance for credit losses. The nature of the process by which the Bank determines the appropriate allowance for credit losses requires the exercise of considerable judgment. Additions or reductions to the allowance for credit losses are made by charges or credits to the provision for credit losses. While management utilizes its business judgment based on the information available, the ultimate appropriateness of the allowance is dependent upon a variety of factors, many of which are beyond the Bank’s control, including but not limited to the performance of the Bank’s loan portfolio, the economy and market conditions, changes in interest rates, and the view of the regulatory authorities toward loan classifications. Identified credit exposures that are determined to be uncollectible are charged against the allowance for credit losses. Recoveries of previously charged-off amounts, if any, are credited to the allowance for credit losses. A weakening of the economy or other factors that adversely affect asset quality could result in an increase in the number of delinquencies, bankruptcies, or defaults, and a higher level of non-performing assets, net charge-offs, and provision for credit losses.

The allowance for loan losses was $144.9 million and the allowance for off-balance sheet unfunded credit commitments was $13.6 million at March 31, 2023, which represented the amount estimated by management to be appropriate to absorb expected credit losses inherent in the loan portfolio, including unfunded credit commitments. The allowance for credit losses, which is the sum of the allowances for loan losses and for off-balance sheet unfunded credit commitments, was $158.5 million at March 31, 2023, compared to $155.2 million at December 31, 2022. The allowance for loan losses represented 0.79% of period-end gross loans, and 167.81% of non-performing loans at March 31, 2023. The comparable ratios were 0.80% of period-end gross loans, and 182.12% of non-performing loans at December 31, 2022.

Critical Accounting Policies and Estimates

Our accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. We identify critical policies and estimates as those that require management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. We have identified the policy and estimates related to the allowance for credit losses on loans as a critical accounting policy.

Our critical accounting policies and estimates are described in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the 2022 Form 10-K. For more information, please also see Note 3 to the Company’s unaudited Consolidated Financial Statements.

Expected Credit Losses Estimate for Loans

The allowance for credit losses is the combination of the allowance for loan losses and the reserve for unfunded loan commitments. The allowance for loan losses is reported as a reduction of the amortized cost basis of loans, while the reserve for unfunded loan commitments is included within "Other liabilities" on the Consolidated Balance Sheets. The amortized cost basis of loans does not include interest receivable, which is included in "Other assets" on the Consolidated Balance Sheets. The "Provision for credit losses" on the Consolidated Statement of Operations and Comprehensive Income is a combination of the provision for loan losses and the provision for unfunded loan commitments.

Under the CECL methodology, expected credit losses reflect losses over the remaining contractual life of an asset, considering the effect of prepayments and available information about the collectability of cash flows, including information about relevant historical experience, current conditions, and reasonable and supportable forecasts of future events and circumstances. Thus, the CECL methodology incorporates a broad range of information in developing credit loss estimates. For further information regarding the calculation of the allowance for credit losses on loans held for investment using the CECL methodology, see Note 9 to the unaudited Consolidated Financial Statements contained in "Item 1. Consolidated Financial Statements."

In calculating our allowance for credit losses in the first quarter of 2023, the change in Moody’s forecast of future GDP, unemployment rates, CRE and home price indexes, did not result in a significant impact to the decrease in the allowance for credit losses. The decrease in the allowance for credit losses was primarily due to net charge-offs of $4.9 million. Our methodology and framework along with the 8-quarter reasonable and supportable forecast period and the 4-quarter reversion period have remained consistent since the implementation of CECL on January 1, 2021. Certain management assumptions are reassessed every quarter based on current expectations for credit losses, while other assumptions are assessed and updated on at least an annual basis.

The use of different economic forecasts, whether based on different scenarios, the use of multiple or single scenarios, or updated economic forecasts and scenarios, can change the outcome of the calculations. In addition to the economic forecasts, there are numerous components and assumptions that are integral to the overall estimation of allowance for credit losses.

The determination of the allowance for credit losses is complex and dependent on numerous models, assumptions, and judgments made by management. Management's current expectation for credit losses as quantified in the allowance for credit losses, considers the impact of assumptions and is reflective of historical credit experience, economic forecasts viewed to be reasonable and supportable, current loan composition, and relative credit risks known as of the balance sheet date.

Under the Company’s CECL methodology, nine portfolio segments with similar risk characteristics are evaluated for expected loss. Six portfolios are modeled using econometric models and three smaller portfolios are evaluated using a simplified loss-rate method that calculates lifetime expected credit losses for the respective pools (simplified approach). The six portfolios subject to econometric modeling include residential mortgages; commercial and industrial loans (“C&I”); construction loans; commercial real estate (“CRE”) for multifamily loans; CRE for owner-occupied loans; and other CRE loans. We estimate the probability of default during the reasonable and supportable forecast period using separate econometric regression models developed to correlate macroeconomic variables, (GDP, unemployment, CRE prices and residential mortgage prices) to historical credit performance for each of the six loan portfolios from 2007 to the fourth quarter of 2021. Loss given default rates are computed based on the net charge-offs recognized and then applied to the expected exposure at default of defaulted loans starting with the fourth quarter of 2007 through the fourth quarter of 2021. The probability of default and the loss given default rates are applied to the expected amount at default at the loan level based on contractual scheduled payments and estimated prepayments. The amounts so calculated comprise the quantitative portion of the allowance for credit losses. The Company’s CECL methodology utilizes an eight-quarter reasonable and supportable (“R&S”) forecast period, and a four-quarter reversion period. Management relies on multiple forecasts, blending them into a single loss estimate. Generally speaking, the blended scenario approach would include the Baseline, the Alternative Scenario 1 – Upside – 10th Percentile and the Alternative Scenario 3 – Downside – 90th Percentile forecasts. After the R&S period, the Company will revert straight-line for the four-quarter reversion period to the long-term loss rates for each of the six portfolios of loans. The contractual term excludes renewals and modifications but includes pre-approved extensions and prepayment assumptions where applicable.

Our allowance for credit losses is sensitive to a number of inputs, including macroeconomic forecast assumptions and credit rating migrations during the period. Our macroeconomic forecasts used in determining the March 31, 2023, allowance for credit losses consisted of three scenarios as provided by an outside forecaster. Because the December 2022 baseline scenario did not forecast a recession in the forecast period, we increased the weighing of the downside scenario to reflect our expectations that a recession in the forecast period was more likely than not. The baseline scenario reflects modest ongoing GDP growth and a modest increase in the unemployment rate peaking at 4.0% in the third quarter of 2024. Relative to the baseline scenario, the upside scenario reflects higher GDP growth and lower unemployment rates with the stronger economy resulting in slightly higher inflation, though the Federal Reserve is projected to cut the Fed funds rate starting in the first quarter of 2024. The downside scenario contemplates a recession due to the weakening economy as concerns about inflation keep the Fed funds rate elevated, increasing to 5.0% in the third quarter of 2023, resulting in negative GDP growth for three quarters peaking at minus 3.1% in the second quarter of 2023, rising unemployment that peaks at 7.8% in the second quarter of 2024, and a decline in CRE prices and residential home prices of over 24% and 16%, respectively, during the forecast period. As of March 31, 2023, we placed the most weight on our downside scenario, with the remaining weighting mainly on the baseline scenario and a small weighting on the upside scenario.

Keeping all other factors constant, we estimate that if we had applied 100% weighting to the downside scenario, the allowance for credit losses as of March 31, 2023, would have been approximately $43.1 million higher. This estimate is intended to reflect the sensitivity of the allowance for credit losses to changes in our scenario weights and is not intended to be indicative of future changes in the allowance for credit losses.

Management believes the allowance for credit losses is appropriate for the current expected credit losses in our loan portfolio and associated unfunded commitments, and the credit risk ratings and inherent loss rates currently assigned are reasonable and appropriate as of the reporting date. It is possible that others, given the same information, may at any point in time reach different conclusions that could result in a significant impact to the Company’s financial statements.

The following table sets forth information relating to the allowance for loan losses, charge-offs, recoveries, and the reserve for off-balance sheet credit commitments for the periods indicated:

(In thousands)

The table set forth below reflects management’s allocation of the allowance for loan losses by loan category and the ratio of each loan category to the average gross loans as of the dates indicated:

(In thousands)

The allowance allocated to commercial loans decreased $3.5 million, or 7.0%, to $46.0 million at March 31, 2023, from $49.4 million at December 31, 2022. The decrease is due primarily to $3.4 million in net charge-offs during the first quarter.

The allowance allocated to real estate construction loans increased $483 thousand, or 4.6%, to $10.9 million at March 31, 2023, from $10.4 million at December 31, 2022. The increase is due primarily to higher risk rating as a result of higher unemployment growth rate.

The allowance allocated to commercial mortgage loans increased $2.0 million, or 2.9%, to $70.4 million at March 31, 2023, from $68.4 million at December 31, 2022. The increase is due primarily to an increase in commercial mortgage loans and an increase in the expected life for multifamily loans as a result of our annual CECL recalibration.

The allowance allocated for residential mortgage loans and equity lines decreased by $599 thousand, or 3.3%, to $17.6 million as of March 31, 2023, from $18.2 million at December 31, 2022. The decrease is due primarily to a decrease in the expected life for residential mortgages as a result of our annual CECL recalibration.

Deposits

Total deposits were $18.65 billion as of March 31, 2023, an increase of $143.6 million, or 0.8%, from $18.51 billion as of December 31, 2022.

Total uninsured deposits were $8.74 billion as of March 31, 2023, decreased approximately $0.46 billion, from $9.21 billion as of December 31, 2022. Excluding $0.80 billion in collateralized deposits, the uninsured and uncollateralized deposits of $7.94 billion was 42.6% of total deposits as of March 31, 2023. Our unused borrowing capacity from the Federal Home Loan Bank as of March 31, 2023 was $6.55 billion and unpledged securities at March 31, 2023 was $1.40 billion. These sources of available liquidity were more than 100% of uninsured and uncollateralized deposits as of March 31, 2023.

The following table sets forth the deposit mix as of the dates indicated:

(In thousands)

The following table sets forth the maturity distribution of time deposits at March 31, 2023:

(In thousands)

Borrowings

Borrowings include Federal funds purchased, funds obtained as advances from the FHLB of San Francisco, and borrowings from other financial institutions.

Borrowings from the FHLB – There were no over-night borrowings from the FHLB as of March 31, 2023, and $150.0 million in over-night borrowings as of December 31, 2022. Advances from the FHLB were $360.0 million at a weighted average rate of 5.0% as of March 31, 2023, and $335.0 million at a weighted average rate of 4.54% as of December 31, 2022. As of March 31, 2023, final maturity for the FHLB advances were $275.0 million in April 2023, $70.0 million in May 2023 and $15.0 million in September 2024.

Junior Subordinated Notes – At March 31, 2023, Junior Subordinated Notes totaled $119.1 million with a weighted average interest rate of 7.04%, compared to $119.1 million with a weighted average rate of 4.01% at December 31, 2022. The Junior Subordinated Notes have a stated maturity term of 30 years. For additional information, see Note 11 to the Company’s unaudited Consolidated Financial Statements.

Off-Balance-Sheet Arrangements and Contractual Obligations

The following table summarizes the Company’s contractual obligations to make future payments as of March 31, 2023. Payments for deposits and borrowings do not include interest. Payments related to leases are based on actual payments specified in the underlying contracts.

(In thousands)

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our Consolidated Balance Sheets. We enter into these transactions to meet the financing needs of our clients. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the Consolidated Balance Sheets.

Loan Commitments – We enter into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon clients maintaining specific credit standards at the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for credit losses.

Standby Letters of Credit – Standby letters of credit are written conditional commitments issued by us to secure the obligations of a client to a third party. In the event the client does not perform in accordance with the terms of an agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek reimbursement from the client. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

Capital Resources

Total equity was $2.54 billion as of March 31, 2023, an increase of $68.3 million, from $2.47 billion as of December 31, 2022, primarily due to net income of $96.0 million, other comprehensive income of $11.2 million, stock-based compensation of $1.5 million, and proceeds from dividend reinvestment of $0.9 million, offset by, common stock cash dividends of $24.6 million and purchase of treasury stock of $16.7 million.

The following table summarizes changes in total equity for the three months ended March 31, 2023:

(In thousands)

Capital Adequacy Review

Management seeks to retain our capital at a level sufficient to support future growth, protect depositors and stockholders, and comply with various regulatory requirements.

The following tables set forth actual and required capital ratios as of March 31, 2023 and December 31, 2022 for Bancorp and the Bank under the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. See the 2022 Form 10-K for a more detailed discussion of the Basel III Capital Rules.

(In thousands)

(In thousands)

As of March 31, 2023, capital levels at Bancorp and the Bank exceed all capital adequacy requirements under the fully phased-in Basel III Capital Rules. Based on the ratios presented above, capital levels as of March 31, 2023 at Bancorp and the Bank exceed the minimum levels necessary to be considered “well capitalized.”

Dividend Policy

Holders of common stock are entitled to dividends as and when declared by our Board of Directors out of funds legally available for the payment of dividends. Although we have historically paid cash dividends on our common stock, we are not required to do so. We increased the common stock dividend from $0.24 per share in the fourth quarter of 2017, to $0.31 per share in the fourth quarter of 2018, to $0.34 per share in the fourth quarter of 2021. The amount of future dividends, if any, will depend on our earnings, financial condition, capital requirements and other factors, and will be determined by our Board of Directors. The terms of our Junior Subordinated Notes also limit our ability to pay dividends. If we are not current in our payment of dividends on our Junior Subordinated Notes, we may not pay dividends on our common stock.

The Company declared a cash dividend of $0.34 per share on 72,367,061 shares outstanding on February 16, 2023, for distribution to holders of our common stock on March 9, 2023. The Company paid total cash dividends of $24.6 million in the first quarter of 2023.

Financial Derivatives

The Company does not speculate on the future direction of interest rates. As part of the Company’s asset and liability management, however, the Company enters into financial derivatives to seek to mitigate exposure to interest rate risks related to its interest-earning assets and interest-bearing liabilities. The Company believes that these transactions, when properly structured and managed, may provide a hedge against inherent interest rate risk in our assets or liabilities and against risk in specific transactions. In such instances, The Company may protect its position. Other hedging transactions may be implemented using interest rate swaps, interest rate caps, floors, financial futures, forward rate agreements, and options on futures or bonds. Prior to considering any hedging activities, the Company seek to analyze the costs and benefits of the hedge in comparison to other viable alternative strategies. All hedges will require an assessment of basis risk and must be approved by the Bancorp or the Bank’s Investment Committee.

The Company follows ASC Topic 815 that establishes accounting and reporting standards for financial derivatives, including certain financial derivatives embedded in other contracts, and hedging activities. It requires the recognition of all financial derivatives as assets or liabilities in the Company’s Consolidated Balance Sheets and measurement of those financial derivatives at fair value. The accounting treatment of changes in fair value is dependent upon whether or not a financial derivative is designated as a hedge and, if so, the type of hedge. Fair value is determined using third-party models with observable market data. For derivatives designated as cash flow hedges, changes in fair value are recognized in other comprehensive income and are reclassified to earnings when the hedged transaction is reflected in earnings. For derivatives designated as fair value hedges, changes in the fair value of the derivatives are reflected in current earnings, together with changes in the fair value of the related hedged item if there is a highly effective correlation between changes in the fair value of the interest rate swaps and changes in the fair value of the underlying asset or liability that is intended to be hedged. If there is not a highly effective correlation between changes in the fair value of the interest rate swap and changes in the fair value of the underlying asset or liability that is intended to be hedged, then only the changes in the fair value of the interest rate swaps are reflected in the Company’s Consolidated Financial Statements.

The Company offers various interest rate derivative contracts to its clients. When derivative transactions are executed with its clients, the derivative contracts are offset by paired trades with third-party financial institutions including with central counterparties (“CCP”). Certain derivative contracts entered with CCPs are settled-to-market daily to the extent the CCP’s rulebooks legally characterize the variation margin as settlement. Derivative contracts are intended to allow borrowers to lock in attractive intermediate and long-term fixed rate financing while not increasing the interest rate risk to the Company. These transactions are generally not linked to specific Company assets or liabilities on the Consolidated Balance Sheets or to forecasted transactions in a hedging relationship and, therefore, are economic hedges. The contracts are marked to market at each reporting period. The changes in fair values of the derivative contracts traded with third-party financial institutions are expected to be largely comparable to the changes in fair values of the derivative transactions executed with clients throughout the terms of these contracts, except for the credit valuation adjustment component. The Company records credit valuation adjustments on derivatives to properly reflect the variances of credit worthiness between the Company and the counterparties, considering the effects of enforceable master netting agreements and collateral arrangements. As of March 31, 2023 and December 31, 2022, the Company had outstanding interest rate derivative contracts with certain clients and third-party financial institutions with a notional amount of $592.5 million and $595.4 million, respectively. As of March 31, 2023 and December 31, 2022, the notional amount of $20.5 million and $205.6 million of interest rate swaps cleared through the CCP, respectively. Applying variation margin payments as settlement to CCP cleared derivative transactions resulted in a reduction in derivative asset fair values of $1.6 million as of March 31, 2023 and $20.2 million as of December 31, 2022. The decrease in interest rate swaps cleared through the CCP is a result of the Company moving to SOFR based swaps and no longer entering into Libor based swaps that are cleared through CCP.

In May 2014, Bancorp entered into interest rate swap contracts in the notional amount of $119.1 million for a period of ten years. The objective of these interest rate swap contracts, which were designated as hedging instruments in cash flow hedges, was to hedge the quarterly interest payments on Bancorp’s $119.1 million of Junior Subordinated Debentures that had been issued to five trusts, throughout the ten-year period beginning in June 2014 and ending in June 2024, from the risk of variability of these payments resulting from changes in the three-month LIBOR interest rate. The Company early terminated these cash flow derivative swaps in 2022 and realized a gain of $4.0 million for the year ended December 31, 2022 and is recognizing the amount as a reduction of long-term debt interest expense over the remaining life of the swaps on a straight-line basis. As of December 31, 2022, the ineffective portion of these interest rate swaps was not significant. The periodic net settlement of the interest rate swaps included in interest expense was a net gain of $689 thousand for the three months ended March 31, 2022.

As of March 31, 2023, the Bank’s outstanding fair value interest rate swap contracts matched to individual fixed-rate commercial real estate loans had a notional amount of $138.2 million for various terms from three to ten years. These contracts have been designated as hedging instruments to hedge the risk of changes in the fair value of the underlying commercial real estate loans due to changes in interest rates. The swap contracts are structured so that the notional amounts reduce over time to match the contractual amortization of the underlying loan and allow prepayments with the same pre-payment penalty amounts as the related loan. As of March 31, 2023, and 2022, the ineffective portion of these interest rate swaps was not significant.

The Company has designated as a partial-term hedging election $669.2 million notional as last-of-layer hedge on pools of loans with a notational value of $1.19 billion as of March 31, 2023. The loans are not expected to be affected by prepayment, defaults, or other factors affecting the timing and amount of cash flows under the last-of-layer method. The Company has entered into these pay-fixed and receive 1-Month LIBOR or 1-Month Term SOFR interest rate swaps to convert the last-of-layer $669.2 million portion of $1.19 billion fixed rate loan pools in order to reduce the Company’s exposure to higher interest rates for the last-of-layer tranches. As of March 31, 2023, the last-of-layer loan tranche had a fair value basis adjustment of $23.7 million. The interest rate swap converts this last-of-layer tranche into a floating rate instrument. The Company’s risk management objective with respect to this last-of-layer interest rate swap is to reduce interest rate exposure as to the last-of-layer tranche.

Interest rate swap contracts involve the risk of dealing with institutional derivative counterparties and their ability to meet contractual terms. Institutional counterparties must have a strong credit profile and be approved by the Company’s Board of Directors. The Company’s credit exposure on interest rate swaps is limited to the net favorable value and interest payments of all swaps by each counterparty. Credit exposure may be reduced by the amount of collateral pledged by the counterparty. Bancorp’s interest rate swaps have been assigned by the counterparties to a derivative clearing organization and daily margin is indirectly maintained with the derivative clearing organization. There was no cash collateral deposit posted by Bancorp related to fair value derivative contracts as of March 31, 2023 or December 31, 2022.

The notional amount and net unrealized loss of the Company’s fair value derivative financial instruments as of March 31, 2023, and December 31, 2022, were as follows:

(In thousands)

(1) the amount is included in other non-interest income.

(2) the amount of periodic net settlement of interest rate swaps was included in interest income.

Included in the total notional amount of $807.3 million of the fair value interest rate contracts entered into with financial counterparties as of March 31, 2023, was a notional amount of $448.7 million of interest rate swaps that cleared through the CCP. Applying variation margin payments as settlement to CCP cleared derivative transactions resulted in a reduction in derivative asset fair values of $22.2 million as of March 31, 2023.

The Company enters into foreign exchange forward contracts with various counterparties to mitigate the risk of fluctuations in foreign currency exchange rates for foreign exchange certificates of deposit or foreign exchange contracts entered into with our clients. These contracts are not designated as hedging instruments and are recorded at fair value in our Consolidated Balance Sheets. Changes in the fair value of these contracts as well as the related foreign exchange certificates of deposit and foreign exchange contracts are recognized immediately in net income as a component of non-interest income. Period end gross positive fair values are recorded in other assets and gross negative fair values are recorded in other liabilities.

The notional amount and fair value of the Company’s derivative financial instruments not designated as hedging instruments as of March 31, 2023, and December 31, 2022, not including interest rate swaps cleared through the CCP, were as follows:

(In thousands)

Liquidity

Liquidity is our ability to maintain sufficient cash flow to meet maturing financial obligations and client credit needs, and to take advantage of investment opportunities as they are presented in the marketplace. Our principal sources of liquidity are growth in deposits, proceeds from the maturity or sale of securities and other financial instruments, repayments from securities and loans, Federal funds purchased, securities sold under agreements to repurchase, and advances from the FHLB. As of March 31, 2023, our average monthly liquidity ratio (defined as net cash plus short-term and marketable securities to net deposits and short-term liabilities) was 13.5% compared to 13.7% as of December 31, 2022.

The Bank is a shareholder of the FHLB, which enables the Bank to have access to lower-cost FHLB financing when necessary. At March 31, 2023, the Bank had an approved credit line with the FHLB of San Francisco totaling $7.69 billion. Total advances from the FHLB of San Francisco were $360.0 million and standby letters of credit issued by the FHLB on the Company’s behalf were $785.1 million as of March 31, 2023. These borrowings bear fixed rates and are secured by the Bank’s loans. See Note 11 to the Consolidated Financial Statements. At March 31, 2023, the Bank pledged $535.4 thousand of its commercial loans and $1.3 million of securities to the Federal Reserve Bank’s Discount Window under the Borrower-in-Custody program. The Bank had borrowing capacity of $1.7 million from the Federal Reserve Bank Discount Window at March 31, 2023.

Liquidity can also be provided through the sale of liquid assets, which consist of federal funds sold, securities purchased under agreements to resell, and securities available-for-sale. At March 31, 2023, investment securities totaled $1.54 billion, with $144.0 million pledged as collateral for borrowings and other commitments. The remaining balance was available as additional liquidity or to be pledged as collateral for additional borrowings. At March 31, 2023, $1.23 billion of unpledged treasuries, U.S. agency securities, U.S. agency mortgage-backed securities or CMO based on current cost are available for pledging to the Federal Reserve Bank’s Bank Term Funding Program.

Approximately 99.3% of our time deposits mature within one year or less as of March 31, 2023. Management anticipates that these deposits will reprice higher as a result of the increases in the target Fed funds rate that started in early 2022. Management anticipates that there may be some outflow of these deposits upon maturity due to the keen competition in the Bank’s marketplace. However, based on our historical runoff experience, we expect the outflow will not be significant and can be replenished through our normal growth in deposits. As of March 31, 2023, management believes all the above-mentioned sources will provide adequate liquidity during the next twelve months for the Bank to meet its operating needs.

The business activities of Bancorp consist primarily of the operation of the Bank and limited activities in other investments. The Bank paid dividends to Bancorp totaling $24.6 million and $25.5 million during the first quarter of 2023 and 2022, respectively.

We use a net interest income simulation model to measure the extent of the differences in the behavior of the lending and funding rates to changing interest rates, to project future earnings or market values under alternative interest rate scenarios. Interest rate risk arises primarily through the Company’s traditional business activities of extending loans and accepting deposits. Many factors, including but not limited to economic, market and financial conditions, movements in interest rates, and consumer preferences, affect the spread between interest earned on assets and interest paid on liabilities. The net interest income simulation model is designed to measure the volatility of net interest income and net portfolio value, defined as net present value of assets and liabilities, under immediate rising or falling interest rate scenarios in 100 basis point increments.

Although the modeling can be helpful in managing interest rate risk, it does require significant assumptions for the projection of loan prepayment rates on mortgage related assets, loan volumes and pricing, and deposit and borrowing volume and pricing, that might prove inaccurate. Because these assumptions are inherently uncertain, the model cannot precisely estimate net interest income, or precisely predict the effect of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes, the differences between actual experience and the assumed volume, changes in market conditions, and management strategies, among other factors. The Company monitors its interest rate sensitivity and seeks to reduce the risk of a significant decrease in net interest income caused by a change in interest rates.

We have established a tolerance level in our policy to define and limit net interest income volatility to a change of plus or minus 5% when the hypothetical rate change is plus or minus 200 basis points. When the net interest rate simulation projects that our tolerance level will be met, or exceeded, we seek corrective action after considering, among other things, market conditions, client reaction, and the estimated impact on profitability. The Company’s simulation model also projects the net economic value of our portfolio of assets and liabilities. We have established a tolerance level in our policy to limit the loss in the net economic value of our portfolio of assets and liabilities to zero when the hypothetical rate change is plus or minus 200 basis points.

The table below shows the estimated impact of changes in interest rates on net interest income and market value of equity as of March 31, 2023:

(1) The percentage change in this column represents net interest income of the Company for 12 months in a stable interest rate environment versus the net interest income in the various rate scenarios. Much of the increase in net interest income is due to the lag in the repricing of certificates of deposits which mature throughout the twelve month period.

(2) The percentage change in this column represents the net portfolio value of the Company in a stable interest rate environment versus the net portfolio value in the various rate scenarios.

The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this quarterly report. Based upon their evaluation, the principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

There has not been any change in our internal control over financial reporting that occurred during the first quarter of 2023 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Except as set forth below, there have been no material changes to the risk factors as previously disclosed in Part I, Item 1A, of the Company’s 2022 Form 10-K. In addition to the below information and the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors disclosed in Part I, Item 1A, of the Company’s 2022 Form 10-K, which could materially and adversely affect the Company’s business, financial condition, results of operations and stock price. The risk factors disclosed in the 2022 Form 10-K, as supplemented by the below, are not the only risks facing the Company. Additional risks and uncertainties, including those not presently known to the Company or that the Company presently believes not to be material, could also materially and adversely affect the Company’s business, financial condition, and results of operations and stock price.

Risks Related to Recent Events Impacting the Financial Services Industry

Recent events impacting the financial services industry, including the failure of Silicon Valley Bank, Signature Bank and First Republic Bank, have resulted in decreased confidence in banks among consumer and commercial depositors, other counterparties and investors, as well as significant disruption, volatility and reduced valuations of equity and other securities of banks in the capital markets. These events occurred during a period of rapidly rising interest rates which, among other things, has resulted in unrealized losses in longer duration securities and loans held by banks, more competition for bank deposits and may increase the risk of a potential recession. These recent events have, and could continue to, adversely impact the market price and volatility of the Company’s common stock.

These recent events may also result in potentially adverse changes to laws or regulations governing banks and bank holding companies or result in the impositions of restrictions through supervisory or enforcement activities, including higher capital requirements, which could have a material impact on our business. Inability to access short-term funding, loss of client deposits or changes in our credit ratings could increase the cost of funding, limit access to capital markets or negatively impact our overall liquidity or capitalization. We may be impacted by concerns regarding the soundness or creditworthiness of other financial institutions, which can cause substantial and cascading disruption within the financial markets and increased expenses. The cost of resolving the recent bank failures may prompt the FDIC to increase its premiums above the recently increased levels or to issue additional special assessments.