Banc of California, Inc.: Form 10-Q for the period ended Jun 30, 2024

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

Forward-Looking Information

This Quarterly Report on Form 10-Q contains certain “forward-looking statements” about the Company and its subsidiaries within the meaning of the Private Securities Litigation Reform Act of 1995, including certain plans, strategies, goals, and projections and including statements about our expectations regarding our operating expenses, profitability, allowance for credit losses, net interest margin, net interest income, deposit growth, loan and lease portfolio growth and production, acquisitions and related integrations, maintaining capital adequacy, liquidity, goodwill, and interest rate risk management. All statements contained in this Quarterly Report on Form 10-Q that are not clearly historical in nature are forward-looking, and the words “anticipate,” “assume,” “intend,” “believe,” “forecast,” “expect,” “estimate,” “plan,” “continue,” “will,” “should,” “look forward” and similar expressions are generally intended to identify forward-looking statements. All forward-looking statements (including statements regarding future financial and operating results and future transactions and their results) involve risks, uncertainties, and contingencies, many of which are beyond our control, which may cause actual results, performance, or achievements to differ materially from anticipated results, performance, or achievements. Actual results could differ materially from those contained or implied by such forward-looking statements for a variety of factors, including without limitation:

• changes in general economic conditions, either nationally or in our market areas, including the impact of supply chain disruptions, and the risk of recession or an economic downturn;
• changes in the interest rate environment, including the recent and potential future changes in the FRB benchmark rate, which could adversely affect our revenue and expenses, the value of assets and obligations, the realization of deferred tax assets, the availability and cost of capital and liquidity, and the impacts of continuing inflation;
• the credit risks of lending activities, which may be affected by deterioration in real estate markets and the financial condition of borrowers, and the operational risk of lending activities, including the effectiveness of our underwriting practices and the risk of fraud, any of which may lead to increased loan delinquencies, losses, and non-performing assets, and may result in our allowance for credit losses not being adequate;
• fluctuations in the demand for loans, and fluctuations in commercial and residential real estate values in our market area;
• the quality and composition of our securities portfolio;
• our ability to develop and maintain a strong core deposit base, including among our venture banking clients, or other low cost funding sources necessary to fund our activities particularly in a rising or high interest rate environment;
• the rapid withdrawal of a significant amount of demand deposits over a short period of time;
• the costs and effects of litigation;
• risks related to the Company's acquisitions, including disruption to current plans and operations; difficulties in customer and employee retention; fees, expenses and charges related to these transactions being significantly higher than anticipated; and our inability to achieve expected revenues, cost savings, synergies, and other benefits; and in the case of our recent merger with PacWest, reputational risk, regulatory risk and potential adverse reactions of the Company's or PacWest's customers, suppliers, vendors, employees or other business partners;
• results of examinations by regulatory authorities of the Company and the possibility that any such regulatory authority may, among other things, limit our business activities, restrict our ability to invest in certain assets, refrain from issuing an approval or non-objection to certain capital or other actions, increase our allowance for credit losses, result in write-downs of asset values, restrict our ability or that of our bank subsidiary to pay dividends, or impose fines, penalties or sanctions;
• legislative or regulatory changes that adversely affect our business, including changes in tax laws and policies, accounting policies and practices, privacy laws, and regulatory capital or other rules;
• the risk that our enterprise risk management framework may not be effective in mitigating risk and reducing the potential for losses;
• errors in estimates of fair values of certain of our assets and liabilities, which may result in significant changes in valuation;
• failures or security breaches with respect to the network, applications, vendors, and computer systems on which we depend, including due to cybersecurity threats;
• our ability to attract and retain key members of our senior management team;
• the effects of climate change, severe weather events, natural disasters, pandemics, epidemics and other public health crises, acts of war or terrorism, and other external events on our business;
• the impact of bank failures or other adverse developments at other banks on general depositor and investor sentiment regarding the stability and liquidity of banks;
• the possibility that our recorded goodwill could become impaired, which may have an adverse impact on our earnings and capital;
• our existing indebtedness, together with any future incurrence of additional indebtedness, could adversely affect our ability to raise additional capital and to meet our debt obligations;
• the risk that we may incur significant losses on future asset sales; and
• other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described in this Quarterly Report on Form 10-Q and from time to time in other documents that we file with or furnish to the SEC.

All forward-looking statements included in this Quarterly Report on Form 10-Q are based on information available at the time the statement is made. We are under no obligation to (and expressly disclaim any such obligation to) update or alter our forward-looking statements, whether as a result of new information, future events or otherwise except as required by law.

Presentation of Results – PacWest Bancorp Merger

On November 30, 2023, PacWest Bancorp merged with and into Banc of California, Inc. (the “Merger” or "PACW Merger"), with Banc of California, Inc. continuing as the surviving legal corporation and Banc of California, Inc. concurrently closed a $400 million equity capital raise. The Merger was accounted for as a reverse merger using the acquisition method of accounting, therefore, PacWest Bancorp was deemed the acquirer for financial reporting purposes, even though Banc of California, Inc. was the legal acquirer. The Merger was an all-stock transaction and has been accounted for as a business combination. Banc of California, Inc.'s financial results for all periods ended prior to November 30, 2023 reflect PacWest Bancorp results only on a standalone basis. In addition, Banc of California, Inc.'s reported financial results for the year ended December 31, 2023 reflect PacWest Bancorp financial results only on a standalone basis until the closing of the Merger on November 30, 2023, and results of the combined company for the month of December 2023. The number of shares issued and outstanding, earnings per share, and all references to share quantities or metrics of Banc of California, Inc. have been retrospectively restated to reflect the equivalent number of shares issued in the Merger as the Merger was accounted for as a reverse merger. Under the reverse merger method of accounting, the assets and liabilities of legacy Banc of California, Inc. as of November 30, 2023 were recorded at their respective fair values.

Overview

Banc of California, Inc., a Maryland corporation, was incorporated in March 2002 and serves as the holding company for its wholly owned subsidiary, Banc of California (the “Bank”), a California state-chartered bank and member of the FRB. When we refer to the “parent” or the “holding company," we are referring to Banc of California, Inc., the parent company, on a stand-alone basis. When we refer to “we,” “us,” “our,” or the “Company,” we are referring to Banc of California, Inc. and its consolidated subsidiaries including the Bank, collectively.

The Bank is a relationship-based community bank focused on providing business banking and treasury management services to small, middle-market, and venture-backed businesses. The Bank offers a broad range of loan and lease and deposit products and services through full-service branches throughout California and in Durham, North Carolina and Denver, Colorado, and loan production offices around the country.

At June 30, 2024, the Company had total assets of $35.2 billion, including $25.2 billion of total loans and leases, net of deferred fees, $2.2 billion of securities available-for-sale, $2.3 billion of securities held-to-maturity, and $2.5 billion of interest-earning deposits in financial institutions compared to $38.5 billion of total assets at December 31, 2023, including $25.6 billion of total loans and leases, net of deferred fees, $2.3 billion of securities available-for-sale, $2.3 billion securities held-to-maturity, and $5.2 billion of interest-earning deposits in financial institutions. The $3.3 billion decrease in total assets since year-end was due primarily to a $2.7 billion decrease in interest-earning deposits in financial institutions.

At June 30, 2024, the Company had total liabilities of $31.8 billion, including total deposits of $28.8 billion and borrowings of $1.4 billion, compared to $35.1 billion of total liabilities at December 31, 2023, including $30.4 billion of total deposits and $2.9 billion borrowings. The $3.3 billion decrease in total liabilities since year-end was due mainly to a $1.6 billion decrease in deposits and a $1.5 billion decrease in borrowings.

The Company had total stockholders' equity of $3.4 billion at June 30, 2024 and at December 31, 2023. Net earnings for the six months ended June 30, 2024 were mostly offset by dividends declared and paid. Our consolidated common equity Tier 1 (CET1), Tier 1 capital and Total capital ratios were 10.27%, 12.62%, and 16.57% at June 30, 2024.

Recent Events

PacWest Bancorp Merger

On November 30, 2023, Banc of California, Inc. completed the Merger, pursuant to which PacWest Bancorp merged with and into Banc of California, Inc., with Banc of California, Inc. continuing as the surviving legal corporation and, as of December 1, 2023, Banc of California, N.A. merged into Pacific Western Bank with Pacific Western Bank continuing under the Banc of California name and brand as the Bank. Concurrent with the completion of the Merger, Banc of California, Inc. also completed its $400 million equity raise from affiliates of funds managed by Warburg Pincus LLC and certain investment vehicles sponsored, managed, or advised by Centerbridge Partners, L.P. and its affiliates. The stock issued by Banc of California, Inc. as consideration in the Merger totaled approximately $663 million.

The Merger was accounted for as a reverse merger using the acquisition method of accounting, therefore, PacWest Bancorp was deemed the accounting acquirer, even though Banc of California, Inc. was the legal acquirer. We recorded the legacy Banc of California, Inc. acquired assets and assumed liabilities, both tangible and intangible, at their estimated fair values as of the acquisition date. The application of the acquisition method of accounting resulted in goodwill of $215.9 million. The Bank is headquartered in Los Angeles, California, and operates more than 80 branches in California, as well as branches in North Carolina and Colorado. We completed the Merger to, among other things, enhance our scale and presence in California and augment and diversify our sources of revenue.

Balance Sheet Repositioning

In connection with the Merger, we implemented our previously announced balance sheet repositioning strategy. From the announcement of the Merger on July 25, 2023, through the end of the year, the combined company, legacy PacWest Bancorp and legacy Banc of California, Inc., sold assets totaling $6.1 billion and completed the paydown of $8.6 billion of high-cost liabilities, which improved the mix of earning assets and reduced the amount of higher-cost funding. The sold assets included $3.9 billion of securities from both the legacy Banc of California, Inc. and PacWest Bancorp portfolios, and $1.5 billion of single-family loans and $0.7 billion of multi-family loans from the legacy Banc of California, Inc. portfolios. The liabilities that were paid down included $4.7 billion of borrowings and $3.9 billion of brokered deposits from both legacy entities.

Key Performance Indicators

Among other factors, our operating results generally depend on the following key performance indicators:

The Level of Net Interest Income

Net interest income is the excess of interest earned on our interest-earning assets over the interest paid on our interest-bearing liabilities. Net interest margin is net interest income (annualized if related to a quarterly period) expressed as a percentage of average interest-earning assets. Tax equivalent net interest income is net interest income increased by an adjustment for tax-exempt interest on certain loans and investment securities based on a 21% federal statutory tax rate. Tax equivalent net interest margin is calculated as tax equivalent net interest income divided by average interest-earning assets.

Net interest income is affected by changes in both interest rates and the volume of average interest-earning assets and interest-bearing liabilities. Our primary interest-earning assets are loans and investment securities, and our primary interest-bearing liabilities are deposits and borrowings. While our deposit balances will fluctuate depending on our customers’ liquidity and cash flow, market conditions, and competitive pressures, we seek to minimize the impact of these variances by attracting a high percentage of noninterest-bearing deposits. Our current priorities are to increase customer deposits to replace brokered deposits, which will reduce our interest expense.

Loan and Lease Production

We actively seek new lending opportunities under an array of lending products. Our lending activities include real estate mortgage loans, real estate construction and land loans, commercial loans and leases, and a small amount of consumer lending. Our commercial real estate loans and real estate construction loans are secured by a range of property types. Our commercial loans and leases portfolio is diverse and generally includes various asset-secured loans, equipment-secured loans and leases, venture capital loans to support venture capital firms’ operations and the operations of entrepreneurial and venture-backed companies during the various phases of their early life cycles, and secured business loans.

Our loan origination process emphasizes credit quality. On occasion, to augment our internal loan production, we have purchased loans such as multi-family loans from other banks, private student loans from third-party lenders, and single-family residential mortgage loans. These loan purchases help us manage the concentrations in our portfolio as they diversify the geographic risk, interest-rate risk, credit risk, and product composition of our loan portfolio. Achieving net loan growth is subject to many factors, including maintaining strict credit standards, competition from other lenders, and borrowers that opt to prepay loans.

The Magnitude of Credit Losses

We emphasize credit quality in originating and monitoring our loans and leases, and we measure our success by the levels of our classified loans and leases, nonaccrual loans and leases, and net charge-offs. We maintain an allowance for credit losses on loans and leases, which is the sum of the allowance for loan and lease losses and the reserve for unfunded loan commitments. Provisions for credit losses are charged to operations as and when needed for both on and off-balance sheet credit exposures. Loans and leases that are deemed uncollectable are charged off and deducted from the allowance for loan and lease losses. Recoveries on loans and leases previously charged off are added to the allowance for loan and lease losses. The provision for credit losses on the loan and lease portfolio is based on our allowance methodology, which considers the impact of assumptions and is reflective of historical experience, economic forecasts viewed to be reasonable and supportable by management, the current loan and lease composition, and relative credit risks known as of the balance sheet date. For originated and acquired credit-deteriorated loans, a provision for credit losses may be recorded to reflect credit deterioration after the origination date or after the acquisition date, respectively.

We regularly review loans and leases to determine whether there has been any deterioration in credit quality resulting from borrower operations or changes in collateral value or other factors which may affect collectability of our loans and leases. Changes in economic conditions, such as the rate of economic growth, the unemployment rate, rate of inflation, increases in the general level of interest rates, declines in real estate values, changes in commodity prices, and adverse conditions in borrowers’ businesses, could negatively impact our borrowers and cause us to adversely classify loans and leases. An increase in classified loans and leases generally results in increased provisions for credit losses and an increased allowance for credit losses. Any deterioration in the commercial real estate market may lead to increased provisions for credit losses because our loans are concentrated in commercial real estate loans.

The Level of Noninterest Expense

Our noninterest expense includes fixed and controllable overhead, the largest components of which are compensation and occupancy expense. It also includes costs that tend to vary based on the volume of activity, such as loan and lease production and the number and complexity of foreclosed assets. We measure success in controlling both fixed and variable costs through monitoring of the ratio of noninterest expense to average total assets.

The following table presents the calculation of our ratio of noninterest expense to average total assets for the periods indicated:

(Dollars in thousands)

(1) Annualized.

Critical Accounting Policies and Estimates

The following discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements and the notes thereto, which have been prepared in accordance with U.S. GAAP. The preparation of the condensed consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the condensed consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable; however, actual results may ultimately differ significantly from these estimates and assumptions, which could have a material adverse effect on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.

Our accounting policies and estimates are fundamental to understanding the following discussion and analysis of financial condition and results of operations. 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. These policies and estimates relate to the allowance for credit losses on loans and leases held for investment, business combinations, the carrying value of goodwill and other intangible assets, and the realization of deferred income tax assets and liabilities.

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 Form 10-K.

Non-GAAP Financial Measures

We use 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. This disclosure should not be viewed as a substitute for results determined in accordance with GAAP. The methodology for determining these non-GAAP measures may differ among companies and may not be comparable. We used the following non-GAAP measures in this Quarterly Report on Form 10-Q:

• Return on average tangible common equity, tangible common equity ratio, and tangible book value per common share: Given that the use of these measures is prevalent among banking regulators, investors, and analysts, we disclose them in addition to the related GAAP measures of return on average equity, equity to assets ratio, and book value per common share, respectively. The reconciliations of these non-GAAP measures to the GAAP measures are presented in the following tables for and as of the periods presented.

(Dollars in thousands)

(1) Effective tax rates of 32.0% and 27.2% used for the three months ended June 30, 2024 and March 31, 2024. Effective tax rate of 29.7% used for the six months ended June 30, 2024. Adjusted effective tax rate of 32.0% used to normalize the effect of goodwill impairment for the six months ended June 30, 2023.

(2) Annualized net earnings (loss) divided by average stockholders' equity.

(3) Annualized adjusted net earnings available to common and equivalent stockholders divided by average tangible common equity.

(Dollars in thousands, except per share data)

(1) Total common equity divided by common and equivalent shares outstanding.

(2) Tangible common equity divided by common and equivalent shares outstanding.

(3) Common and equivalent shares outstanding include non-voting common stock equivalents that are participating securities.

Results of Operations

Earnings Performance

The following table presents performance metrics for the periods indicated:

(Dollars in thousands, except per share data)

(1) Shares include non-voting common stock equivalents that are participating securities.

(2) See "- Non-GAAP Financial Measurements."

Second Quarter of 2024 Compared to First Quarter of 2024

Net earnings available to common and equivalent stockholders for the second quarter of 2024 was $20.4 million, or $0.12 per diluted share, compared to a net earnings available to common and equivalent stockholders for the first quarter of 2024 of $20.9 million, or $0.12 per diluted share. The $0.5 million decrease in net earnings available to common and equivalent stockholders from the first quarter of 2024 was due mainly to lower noninterest income of $4.0 million, higher provision for credit losses of $1.0 million, and higher income tax expense of $2.8 million, offset partially by higher net interest income of $0.4 million and lower noninterest expense of $6.9 million. The decrease in noninterest income was due mainly to a decrease of $2.9 million in other income and a decrease of $1.9 million in dividends and gains on equity investments. The increase in income tax expense was due to higher pre-tax income for the second quarter compared to the first quarter and a higher effective tax rate of 32.0% for the second quarter compared to 27.2% for the first quarter. Net interest income was higher in the second quarter compared to the first quarter due to lower interest expense on interest-bearing liabilities, offset partially by lower interest income on interest-earning assets. The decrease in noninterest expense was due mainly to decreases of $12.7 million in acquisition, integration and reorganization costs and $6.3 million in compensation expense, offset partially by increases of $6.0 million in insurance and assessments expense and $5.1 million in other expense.

Net earnings available to common and equivalent stockholders for the six months ended June 30, 2024 was $41.3 million, or $0.25 per diluted share, compared to a net loss available to common and equivalent stockholders for the six months ended June 30, 2023 of $1.4 billion, or a loss of $18.21 per diluted share. The $1.5 billion increase in net earnings available to common and equivalent stockholders was due mainly to a $1.5 billion decrease in noninterest expense and a $155.3 million increase in noninterest income, offset partially by a $6.8 million decrease in net interest income, a $16.0 million increase in the provision for credit losses, and a $157.8 million increase in income tax expense. The decrease in noninterest expense was due, in part, to a $1.38 billion goodwill impairment charge in the first quarter of 2023. The increase in noninterest income was due almost entirely to a decrease in the loss on sale of loans and leases of $156.6 million. The decrease in net interest income was due primarily to lower interest income on lower interest-earning assets and higher interest expense on deposits, offset partially by lower interest expense on borrowings. The increase in income tax expense was due to the income tax expense recorded on earnings before taxes in the six months ended June 30, 2024, compared to an income tax benefit recorded on a net loss before income taxes in the six months ended June 30, 2023.

Net Interest Income

The following tables summarize the distribution of average assets, liabilities, and stockholders’ equity, as well as interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities, presented on a tax equivalent basis, for the periods indicated:

(Dollars in thousands)

(1) Includes net loan discount accretion of $21.8 million and $22.4 million for the three months ended June 30, 2024 and March 31, 2024.

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

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

(Dollars in thousands)

(1) Tax equivalent.

(2) Includes net loan discount accretion of $44.3 million for the six months ended June 30, 2024 and net loan premium amortization of $4.4 million for the six months ended June 30, 2023.

(3) Includes tax-equivalent adjustments of $0.0 million and $2.3 million for the six months ended June 30, 2024 and 2023, related to tax-exempt income on loans. The federal statutory rate utilized was 21%.

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

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

Second Quarter of 2024 Compared to First Quarter of 2024

Net interest income increased by $0.4 million to $229.5 million for the second quarter of 2024 compared to $229.1 million for the first quarter of 2024 due to lower interest expense on interest-bearing liabilities, offset partially by lower interest income on interest-earning assets.

Average interest-earning assets decreased by $1.7 billion to $32.9 billion for the second quarter of 2024 due mainly to the $1.4 billion decrease in average deposits in financial institutions which was attributable to a $1.0 billion paydown of BTFP in the second quarter of 2024. The NIM was 2.80% for the second quarter of 2024 compared to 2.66% for the first quarter of 2024 due to the average yield on interest-earning assets increasing by 9 basis points, while the average total cost of funds decreased by 7 basis points, which was positively impacted by an increase in average noninterest-bearing deposits. The average yield on interest-earning assets increased by 9 basis points to 5.65% for the second quarter from 5.56% in the first quarter due mainly to the increase in the average yield on loans and leases.

The average yield on loans and leases increased by 10 basis points to 6.18% for the second quarter of 2024 from 6.08% for the first quarter of 2024 as a result of new originations being at rates higher than the existing portfolio and the change in the mix of loan product balances.

The average total cost of funds decreased by 7 basis points to 2.95% for the second quarter from 3.02% in the first quarter due mainly to decreases in average interest-bearing deposits combined with an increase in average noninterest-bearing deposits. The average cost of interest-bearing liabilities increased by 1 basis point to 3.93% for the second quarter from 3.92% for the first quarter. The average total cost of deposits decreased by 6 basis points to 2.60% for the second quarter compared to 2.66% in the first quarter. Average noninterest-bearing deposits increased by $196.6 million for the second quarter compared to the first quarter and average total deposits decreased by $655.5 million.

Net interest income decreased by $6.8 million to $458.6 million for the six months ended June 30, 2024 compared to $465.3 million for the six months ended June 30, 2023 due to lower interest income on lower interest-earning assets and higher interest expense on deposits, offset partially by lower interest expense on borrowings.

Average interest-earning assets decreased by $6.5 billion to $33.8 billion for the first six months of 2024 due to sales of non-core loan portfolios in the second quarter of 2023, fourth quarter of 2023 securities sales, and lower cash balances due to the pay down of higher-cost borrowings in 2024 offset partially by the fourth quarter of 2023 acquisition of legacy Banc of California loans. The NIM increased by 39 basis points to 2.73% for the six months ended June 30, 2024 compared to 2.34% for the same period in 2023 due to the average yield on interest-earning assets increasing by 29 basis points, while the average total cost of funds decreased by 8 basis points.

The average yield on interest-earning assets increased by 29 basis points to 5.60% for the first six months of 2024 from 5.31% for the same period in 2023 due mainly to the change in the interest-earning asset mix. This was driven by the increase in the balance of average loans and leases as a percentage of average interest-earning assets to 75% for the six months ended June 30, 2024 from 69% for the six months ended June 30, 2023, the decrease in the balance of average investment securities as a percentage of average interest-earning assets to 14% for the first six months of 2024 from 18% for comparable period in 2023, and the decrease in the balance of average deposits in financial institutions as a percentage of average interest-earning assets to 11% for the six months ended June 30, 2024 from 13% for the same period in 2023.

The average yield on loans and leases increased by 2 basis points to 6.13% for the first six months of 2024 from 6.11% for the same period in 2023 as a result of changes in portfolio mix and higher net accretion of loan discounts/premiums.

The average total cost of funds decreased by 8 basis points to 2.99% for the six months ended June 30, 2024 from 3.07% for the six months ended June 30, 2023 due mainly to changes in the total funds mix. This was driven by the increase in the balance of lower cost average total deposits as a percentage of average total funds to 90% for the first six months of 2024 from 76% for the comparable period in 2023, and the decrease in the balance of higher cost average borrowings as a percentage of average total funds to 8% for the six months ended June 30, 2024 from 22% for the same period in 2023. The average cost of interest-bearing liabilities increased by 6 basis points to 3.93% for the first six months of 2024 from 3.87% for the comparable period in 2023. The average total cost of deposits increased by 36 basis points to 2.63% for the six months ended June 30, 2024 compared to 2.27% for the six months ended June 30, 2023. Average noninterest-bearing deposits decreased by $305.9 million for the first six months of 2024 compared to the same period in 2023 and average total deposits decreased by $545.6 million.

Provision for Credit Losses

The following table sets forth the details of the provision for credit losses on loans and leases held for investment and held-to-maturity securities and information regarding credit quality metrics for the periods indicated:

(Dollars in thousands)

(1) See "- Balance Sheet Analysis - Allowance for Credit Losses on Loans and Leases Held for Investment" for detail of charge-offs and recoveries by loan portfolio segment, class, and subclass for the periods presented.

Provisions for credit losses are charged to earnings for the allowance for loan and lease losses, the reserve for unfunded loan commitments, and the allowance for credit losses on held-to-maturity securities. The provision for credit losses on our loans and leases held for investment is based on our allowance methodology and is an expense that, in our judgment, is required to maintain an adequate allowance for credit losses. For further details on our loan-related allowance for credit losses methodology, see “- Balance Sheet Analysis - Allowance for Credit Losses on Loans and Leases Held for Investment” contained herein.

Second Quarter of 2024 Compared to First Quarter of 2024

The provision for credit losses was $11.0 million for the second quarter compared to $10.0 million for the first quarter. The $11.0 million second quarter provision was driven mainly by higher net charge-offs, higher qualitative reserves for office loans and other concentrations of credit, and an increase in special mention and classified loans and leases, offset partially by the reserves released for the Civic loans transferred to held for sale. The $10.0 million first quarter provision was driven by an increase in qualitative reserves related to loans secured by office properties and an increase in quantitative reserves due to an increase in nonaccrual and classified loans and leases.

The provision for credit losses increased by $16.0 million to $21.0 million for the six months ended June 30, 2024 compared to $5.0 million for the six months ended June 30, 2023. The higher provision in the 2024 period was generally due to higher net charge-offs, higher qualitative reserves, and higher levels of special mention and classified loans and leases, offset partially by the reserves released for the Civic loans transferred to held for sale.

Certain circumstances may lead to increased provisions for credit losses on loans and leases in the future. Examples of such circumstances include deterioration in economic conditions and forecasts, an increased amount of classified and/or criticized loans and leases, and net loan and lease and unfunded commitment growth. Deterioration in economic conditions and forecasts include the rate of economic growth, the unemployment rate, the rate of inflation, changes in the general level of interest rates, changes in real estate values, and adverse conditions in borrowers’ businesses. See further discussion in “- Balance Sheet Analysis - Allowance for Credit Losses on Loans and Leases Held for Investment” contained herein.

Noninterest Income

The following table summarizes noninterest income by category for the periods indicated:

(In thousands)

Second Quarter of 2024 Compared to First Quarter of 2024

Noninterest income decreased by $4.0 million to $29.8 million for the second quarter of 2024 due mainly to a decrease of $2.9 million in other income (negative fair value mark on credit-linked notes) and a decrease of $1.9 million in dividends and gains on equity investments (negative fair value mark on Small Business Investment Company (“SBIC”) investments partially offset by higher income distributions from SBIC investments), offset partially by an increase of $1.6 million in gain on sale of loans.

Noninterest income increased by $155.3 million to $63.6 million for the six months ended June 30, 2024 compared to a loss of $91.7 million for the six months ended June 30, 2023 due almost entirely to a decrease in the loss on sale of loans and leases of $156.6 million. The Company sold $529.6 million of loans for a net gain of $0.7 million in the six months ended June 30, 2024 and $5.4 billion of loans for a net loss of $155.9 million in the six months ended June 30, 2023.

Noninterest Expense

The following table summarizes noninterest expense by category for the periods indicated:

(In thousands)

Second Quarter of 2024 Compared to First Quarter of 2024

Noninterest expense decreased by $6.9 million to $203.6 million for the second quarter of 2024 compared to the first quarter of 2024 due mainly to decreases of $12.7 million in acquisition, integration and reorganization costs and $6.3 million in compensation expense, offset partially by increases of $6.0 million in insurance and assessments expense and $5.1 million in other expense. The decrease in acquisition, integration and reorganization costs was due to actual amounts for certain expenses being lower than the estimated amounts accrued at merger close. The decrease in compensation expense was mostly due to a lower headcount. The increase in insurance and assessments expense was due to higher assessment rates for both the regular FDIC assessment and the special assessment. The increase in other expense was mostly due to a repurchase reserve recorded for standard representations and warranties associated with the Civic loan sale.

Noninterest expense decreased by $1.5 billion to $414.2 million for the six months ended June 30, 2024 compared to $1.9 billion for the six months ended June 30, 2023 due mainly to a $1.4 billion goodwill impairment recorded in the 2023 period and a $107.2 million decrease in other expense as the 2023 period included $106.8 million of fair value loss adjustments related to sold unfunded loan commitments.

Income Taxes

Second Quarter of 2024 Compared to First Quarter of 2024

Income tax expense of $14.3 million was recorded for the second quarter resulting in an effective tax rate of 32.0% compared to tax expense of $11.5 million for the first quarter and an effective tax rate of 27.2%. The increase is due primarily to an increase in disallowed executive compensation expense and a higher shortfall on equity compensation expense from second quarter restricted stock vesting.

Income tax expense of $25.9 million was recorded for the six months ended June 30, 2024 resulting in an effective tax rate of 29.7% compared to a benefit of $131.9 million for the same period in 2023 and an effective tax rate of 8.7%. Excluding goodwill impairment, the effective tax rate for the six months ended June 30, 2023 was 22.7%. The increase is primarily due to a higher shortfall on equity compensation expense from restricted stock vesting in the second quarter of 2024.

Balance Sheet Analysis

Securities Available-for-Sale

The following table presents the composition and durations of our securities available-for-sale as of the dates indicated:

(Dollars in thousands)

Securities Held-to-Maturity

The following table presents the composition and durations of our securities held-to-maturity as of the dates indicated:

(Dollars in thousands)

84

The following table shows the geographic composition of the majority of our held-to-maturity municipal securities portfolio as of the date indicated:

(Dollars in thousands)

85

Loans and Leases Held for Investment

The following table presents the composition of our loans and leases held for investment, net of deferred fees, by loan portfolio segment, class, and subclass as of the dates indicated:

(Dollars in thousands)

(1) Includes land and acquisition and development loans of $213.6 million at June 30, 2024 and $228.9 million at December 31, 2023.

The following table presents the geographic composition of our real estate loans held for investment, net of deferred fees, by the top 10 states and all other states combined (in the order presented for the current quarter-end) as of the dates indicated:

(Dollars in thousands)

Due to hybrid and remote working policies adopted by most companies during the COVID-19 pandemic which remain in place today, there are concerns over the utilization of commercial office space which could impact the long-term performance of some types of office properties within our commercial real estate portfolio. Furthermore, higher interest rates have presented a new emerging risk for the variable rate and hybrid loans in our portfolio. Due to these concerns and concentrations of credit associated with commercial real estate loans, excluding owner occupied real estate loans, we have increased the qualitative reserve component of our allowance for credit losses for our office loan exposure. At June 30, 2024, mortgage loans secured by office properties represent 3.9% of total loans and leases held for investment.

The risks outlined above result from market conditions and are not controllable by us. However, when considering the markets in which to pursue real estate loans, we consider the market conditions, our current loan portfolio concentrations by property type and by market, and our past experiences with the borrower, within the specific market, and with the property type.

When underwriting real estate loans, we seek to mitigate risk by using the following framework:

• Requiring our borrowers to invest and maintain a meaningful cash equity interest in the properties securing our loans;
• Reviewing each loan request and renewal individually;
• Using a credit committee approval process for the approval of loan requests (or aggregated credit exposures) over a certain dollar amount;
• Adhering to written loan acceptance standards, including among other factors, maximum loan to acquisition cost ratios, maximum loan to as-is or stabilized value ratios, and minimum operating cash flow requirements;
• Considering market rental and occupancy rates relative to our underwritten or projected rental and occupancy rates;
• Considering the experience of our borrowers and our borrowers' abilities to operate and manage the properties securing our loans;
• Evaluating the supply of comparable real estate and new supply under construction in the collateral's market area;
• Obtaining independent third party appraisals that are reviewed by our appraisal department; and
• Obtaining environmental risk assessments.

The following table presents a roll forward of loans and leases held for investment, net of deferred fees, for the period indicated:

(In thousands)

88

Allowance for Credit Losses on Loans and Leases Held for Investment

The allowance for credit losses on loans and leases held for investment is the combination of the allowance for loan and lease losses and the reserve for unfunded loan commitments. The allowance for loan and lease losses is reported as a reduction of the amortized cost basis of loans and leases, while the reserve for unfunded loan commitments is included within "Accrued interest payable and other liabilities" on the consolidated balance sheets. The amortized cost basis of loans and leases does not include accrued interest receivable, which is included in "Other assets" on the condensed consolidated balance sheets. The "Provision for credit losses" on the condensed consolidated statement of earnings (loss) is a combination of the provision for loan and lease losses, the provision for unfunded loan commitments, and the provision for held-to-maturity debt securities.

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 and leases held for investment using the CECL methodology, see Note 1. Nature of Operations and Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements contained in "Item 8. Financial Statements and Supplementary Data" of our Form 10-K.

In calculating our allowance for credit losses, we continued to consider higher inflation rates, the Federal Reserve's monetary policy, the risk of a recession, technical or otherwise, and the impact of various geopolitical risks on the economy in our process for estimating expected credit losses given the changes in economic forecasts and assumptions along with the uncertainty related to the severity and duration of the economic consequences resulting from such events. Our methodology and framework along with the 4-quarter reasonable and supportable forecast period and 2-quarter reversion period have remained consistent since the implementation of CECL on January 1, 2020. 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.

For the second quarter of 2024, we used the Moody’s June 30, 2024 Baseline, S2 Downside 75th Percentile, and S7 Next-Cycle Recession forecast scenarios for the calculation of our quantitative component. The weightings of the scenarios were based on management’s current expectations for the economic forecast, acknowledging the risk of recession over our reasonable and supportable forecast period and inherent uncertainty in the economy. Compared to the first quarter of 2024, the economic forecasts were relatively consistent, resulting in an immaterial impact to the allowance for credit losses.

The primary driver behind lower quantitative reserves compared to the prior quarter were lower loan balances in the held for investment portfolio driven by the reclassification of approximately $1.9 billion of Civic loans to held for sale and payoffs/lower balances on existing loans along with charge-off activity associated with individually evaluated loans that had a specific reserve at the prior quarter-end. The decrease in quantitative reserves was partially offset by higher reserves due to risk rating migration.

As part of our allowance for credit losses methodology, we consistently incorporate the use of qualitative factors in determining the overall allowance for credit losses to capture risks that may not be adequately reflected in our quantitative models. Such qualitative factors may include, but are not limited to: economic conditions not captured in in the quantitative reserve; collateral dependency related to certain loan portfolios including loans secured by office properties that were directly impacted by flexible/hybrid work environment; concentrations of credit within the loan portfolio including the commercial real estate portfolio; the quality of the Company’s credit review system; the volume and severity of adversely classified financial assets; the Company’s lending policies and procedures; and the effect of other external factors such as the regulatory and legal environments. During the second quarter of 2024, reserves associated with the qualitative adjustments increased when compared to the prior quarter. Primary qualitative adjustments are related to loans secured by office properties and concentration of credit associated with commercial real estate loans, excluding owner occupied real estate loans.

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. As part of our allowance for credit losses process, sensitivity analyses are performed to assess the impact of how changing certain assumptions could impact the estimated allowance for credit losses. At times, these analyses can provide information to further assist management in making decisions related to certain assumptions. We calculated alternative values for our ACL using various alternative forecast scenarios weightings and the calculated amounts for the quantitative component differed from the probability-weighted multiple scenario forecast ranging from lower reserves by 3.12% to higher reserves by 3.88%. However, changing one assumption and not reassessing other assumptions used in the quantitative or qualitative process could yield results that are not reasonable or appropriate, hence all assumptions and information must be considered. From a sensitivity analysis perspective, changing key assumptions such as the macro-economic variable inputs from the economic forecasts, the reasonable and supportable forecast period, prepayment rates, loan segmentation, historical loss factors and/or periods, among others, would all change the outcome of the quantitative components of the allowance for credit losses. Those results would then need to be assessed from a qualitative perspective potentially requiring further adjustments to the qualitative component to arrive at a reasonable and appropriate allowance for credit losses.

The determination of the allowance for credit losses is complex and highly dependent on numerous models, assumptions, and judgments made by management. Management's current expectation for credit losses on loans and leases held for investment 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 and lease composition, and relative credit risks known as of the balance sheet date.

Management believes the allowance for credit losses is appropriate for the current expected credit losses in our loan and lease portfolio and associated unfunded loan 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 presents information regarding the allowance for credit losses on loans and leases held for investment as of the dates indicated:

(Dollars in thousands)

90

The following table presents the changes in our allowance for credit losses on loans and leases held for investment for the periods indicated:

(Dollars in thousands)

91

The following table presents charge-offs by loan portfolio segment, class, and subclass for the periods indicated:

(In thousands)

92

The following table presents recoveries by portfolio segment, class, and subclass for the periods indicated:

(In thousands)

93

Deposits

The following table presents the composition of our deposit portfolio by account type as of the dates indicated:

(Dollars in thousands)

The following table presents time deposits based on the $250,000 FDIC insured limit as of the dates indicated:

(Dollars in thousands)

During the six months ended June 30, 2024, total deposits decreased by $1.6 billion, or 5.3%, to $28.8 billion at June 30, 2024 due primarily to a decrease of $1.4 billion in money market accounts and a decrease of $0.5 billion in interest-bearing checking accounts. At June 30, 2024, noninterest-bearing deposits totaled $7.8 billion, or 27%, of total deposits and interest-bearing deposits totaled $21.0 billion, or 73%, of total deposits.

As of June 30, 2024, FDIC-insured deposits represented approximately 74% of total deposits, including accounts eligible for pass-through insurance, down from 76% as of December 31, 2023. Available liquidity (on-balance sheet liquidity plus unused borrowing capacity and unpledged AFS securities) was $16.9 billion at June 30, 2024, which exceeded uninsured and uncollateralized deposits of $6.8 billion, with a coverage ratio of 247% as compared to a coverage ratio of 247% at December 31, 2023. Available liquidity also represented 59% of total deposits at June 30, 2024.

The Bank is a participant in the IntraFi Network, a network that offers deposit placement services such as ICS and CDARS, and other reciprocal deposit networks which offer products that qualify large deposits for FDIC insurance. At June 30, 2024, the Bank had $8.0 billion of reciprocal deposits compared to $8.9 billion at December 31, 2023.

The following table summarizes the maturities of time deposits as of the date indicated:

Client Investment Funds

In addition to deposit products, we also offer select clients non-depository cash investment options through BAM, our registered investment adviser subsidiary, and third-party money market sweep products. BAM provides customized investment advisory and asset management solutions. At June 30, 2024, total off-balance sheet client investment funds were $1.2 billion, of which $0.7 billion was managed by BAM. At December 31, 2023, total off-balance sheet client investment funds were $0.6 billion, of which $0.2 billion was managed by BAM.

Credit Quality

Nonperforming Assets, Classified Loans and Leases, and Special Mention Loans and Leases

The following table presents information on our nonperforming assets, classified loans and leases, and special mention loans and leases as of the dates indicated:

(Dollars in thousands)

Nonaccrual Loans and Leases Held for Investment

The following table presents our nonaccrual loans and leases held for investment and accruing loans and leases past due between 30 and 89 days by loan portfolio segment and class as of the dates indicated:

(In thousands)

96

During the six months ended June 30, 2024, nonperforming loan and leases held for investment increased by $42.8 million to $117.1 million at June 30, 2024 due mainly to additions of $119.0 million, offset partially by transfers to held for sale of $19.6 million, transfers to accrual status of $14.1 million, charge-offs of $13.6 million, and principal and other reductions of $29.0 million. As of June 30, 2024, the Company's three largest loan relationships on nonaccrual status had an aggregate carrying value of $35.9 million and represented 31% of total nonaccrual loans and leases.

Loans and leases accruing 30-89 days past due generally fluctuate from period to period. The $76.8 million decrease to $25.1 million as of June 30, 2024 was due mainly to decreases in other residential and commercial real estate delinquent loans.

Foreclosed Assets

The following table presents foreclosed assets (primarily OREO), net of the valuation allowance, by property type as of the dates indicated:

(In thousands)

During the six months ended June 30, 2024, foreclosed assets increased by $5.9 million to $13.3 million at June 30, 2024 due mainly to additions of $14.8 million, offset partially by sales of $8.1 million.

Classified and Special Mention Loans and Leases Held for Investment

The following table presents the credit risk ratings of our loans and leases held for investment, net of deferred fees, as of the dates indicated:

(In thousands)

Classified and special mention loans and leases fluctuate from period to period as a result of loan repayments and downgrades or upgrades from our ongoing active portfolio management.

The following table presents the classified and special mention credit risk rating categories for loans and leases held for investment, net of deferred fees, by loan portfolio segment and class and the related net changes as of the dates indicated:

(In thousands)

During the six months ended June 30, 2024, classified loans and leases increased by $187.1 million to $415.5 million at June 30, 2024 due mainly to increases of $112.8 million in commercial real estate mortgage classified loans, $39.6 million in multi-family real estate mortgage classified loans, $13.8 million in other residential real estate mortgage classified loans, and $12.5 million in venture capital classified loans.

During the six months ended June 30, 2024, special mention loans and leases increased by $167.4 million to $680.7 million at June 30, 2024 due mainly to increases of $107.4 million in commercial real estate construction and land special mention loans, $90.4 million in venture capital special mention loans, and $54.1 million in commercial real estate mortgage special mention loans, offset partially by decreases of $53.5 million in multi-family real estate mortgage special mention loans and $32.8 million in other residential real estate mortgage special mention loans.

Regulatory Matters

Capital

Bank regulatory agencies measure capital adequacy through standardized risk-based capital guidelines that compare different levels of capital (as defined by such guidelines) to risk-weighted assets and off-balance sheet obligations. At June 30, 2024, banks considered to be “well capitalized” must maintain a minimum Tier 1 leverage ratio of 5.00%, a minimum common equity Tier 1 risk-based capital ratio of 6.50%, a minimum Tier 1 risk-based capital ratio of 8.00%, and a minimum Total risk-based capital ratio of 10.00%.

Regulatory capital requirements limit the amount of deferred tax assets that may be included when determining the amount of regulatory capital. Deferred tax asset amounts in excess of the calculated limit are disallowed from regulatory capital. At June 30, 2024, such disallowed amounts was $252.8 million for the Company. No assurance can be given that the regulatory capital deferred tax asset limitation will not increase in the future or that the Company will not have increased deferred tax assets that are disallowed.

Basel III currently requires all banking organizations to maintain a 2.50% capital conservation buffer above the minimum risk-based capital requirements to avoid certain limitations on capital distributions, stock repurchases and discretionary bonus payments to executive officers. The capital conservation buffer is exclusively comprised of common equity Tier 1 capital, and it applies to each of the three risk-based capital ratios but not to the leverage ratio. Effective January 1, 2019, the common equity Tier 1, Tier 1, and Total capital ratio minimums inclusive of the capital conservation buffer were 7.00%, 8.50%, and 10.50%. At June 30, 2024, the Company and the Bank were in compliance with the capital conservation buffer requirements.

The Company and the Bank elected the CECL 5-year regulatory transition guidance for calculating regulatory capital ratios and the June 30, 2024 ratios include this election. This regulatory guidance allows an entity to add back to capital 100% of the capital impact from the day one CECL transition adjustment and 25% of subsequent increases to the allowance for credit losses through December 31, 2021. This cumulative amount is now being phased out of regulatory capital evenly over the three years from 2022 to 2024. The add-back as of June 30, 2024 ranged from 0 basis points to 3 basis points for the capital ratios below.

The following tables present a comparison of our actual capital ratios to the minimum required ratios and well capitalized ratios as of the dates indicated:

The Company's consolidated risk-based capital ratios increased during the six months ended June 30, 2024 due mainly to a decrease in risk-weighted assets and positive earnings for the period. The consolidated Tier 1 leverage ratio increased during the six months ended June 30, 2024 due mainly to a decrease in average assets attributable primarily to decreased cash and cash equivalents.

Subordinated Debt

We issued or assumed through mergers subordinated debt to trusts that were established by us or entities we acquired, which, in turn, issued trust preferred securities. As of June 30, 2024, the carrying value of subordinated debt totaled $939.3 million. At June 30, 2024, $131.0 million of the trust preferred securities were included in the Company's Tier I capital and $793.4 million were included in Tier II capital.

Dividends on Common Stock and Interest on Subordinated Debt

As a bank holding company, Banc of California, Inc. is required to notify and receive approval from the FRB prior to declaring and paying a dividend to common stockholders during any period in which quarterly and/or cumulative twelve-month net earnings are insufficient to fund the dividend amount, among other requirements. Interest payments made on subordinated debt are considered dividend payments under FRB regulations. We may not pay a dividend if the FRB objects or until such time as we receive approval from the FRB or we no longer need to provide notice under applicable regulations. The Company currently is required to receive FRB approval to declare or pay a dividend to stockholders. Further, if the Company defaults or elects to defer the interest payments on its subordinated debt, it is restricted from paying dividends on its Series F preferred and common stock.

Dividends on Preferred Stock

The Company's ability to pay dividends on the Series F preferred stock depends on the ability of the Bank to pay dividends to the holding company. The ability of the Company and the Bank to pay dividends in the future is subject to bank regulatory requirements, including capital regulations and policies established by the FRB, and the DFPI, as applicable. Dividends on the Series F preferred stock will not be declared, paid, or set aside for payment to the extent such act would cause us to fail to comply with applicable laws and regulations, including applicable FRB capital adequacy regulations and policies.

Dividends on the Series F preferred stock are not cumulative or mandatory. If the Company's Board of Directors does not declare a dividend on the Series F preferred stock in respect of a dividend period, then no dividend shall be deemed to be payable for such dividend period or be cumulative, and the Company will have no obligation to pay any dividend for that dividend period, whether or not the Board of Directors declares a dividend on the Series F preferred stock or any other class or series of its capital stock for any future dividend period. However, if dividends on the Series F preferred stock have not been declared or paid for the equivalent of six dividend payments, whether or not for consecutive dividend periods, holders of the outstanding shares of Series F preferred stock, together with holders of any other series of the Company's preferred stock ranking equal with the Series F preferred stock with similar voting rights, will generally be entitled to vote for the election of two additional directors. Additionally, so long as any share of Series F preferred stock remains outstanding, unless dividends on all outstanding shares of Series F preferred stock for the most recently completed dividend period have been paid in full or declared and a sum sufficient for the payment thereof has been set aside for payment, no dividend shall be declared or paid or set aside for payment and no distribution shall be declared or made or set aside for payment on the Company's common stock.

Liquidity

Liquidity Management

Liquidity is the ongoing ability to accommodate liability maturities and deposit withdrawals, fund asset growth and business operations, and meet contractual obligations through unconstrained access to funding at reasonable market rates. Liquidity management involves forecasting funding requirements and maintaining sufficient capacity to meet the needs and accommodate fluctuations in asset and liability levels due to changes in the Company’s business operations or unanticipated events.

We have a Management Finance Committee ("MFC") that is comprised of members of senior management and is responsible for managing commitments to meet the needs of customers while achieving our financial objectives. MFC meets regularly to review funding capacities, current and forecasted loan demand, and investment opportunities.

We manage our liquidity by maintaining pools of liquid assets on-balance sheet, consisting of cash and receivables due from banks, interest-earning deposits in other financial institutions, and unpledged available-for-sale securities, which we refer to as our primary liquidity. We also maintain available borrowing capacity under secured credit lines with the FHLB and the FRBSF, which we refer to as our secondary liquidity.

As a member of the FHLB, the Bank had secured borrowing capacity with the FHLB of $6.7 billion at June 30, 2024, and $372.9 million pledged for letters of credit and a balance outstanding of $600.0 million as of that date. The FHLB secured credit line was collateralized by a blanket lien on $10.6 billion of certain qualifying loans and $20.2 million of securities. The Bank also had secured borrowing capacity with the FRBSF under the Discount Window program totaling $6.6 billion at June 30, 2024, all of which was available, and $545.0 million under the Bank Term Funding Program, which was fully borrowed as of that date. The FRBSF Discount Window secured credit line was collateralized by liens on $7.1 billion of qualifying loans and $1.1 billion of pledged securities, and the Bank Term Funding Program credit line was collateralized by pledged securities with a market value of $481.9 million and a par value of $584.4 million. The Bank Term Funding Program provides borrowing capacity on qualifying government and government agency guaranteed securities based on the collateral par value.

In addition to its secured lines of credit with the FHLB and FRBSF, the Bank also maintains unsecured lines of credit for the purpose of borrowing overnight funds, subject to availability, of $290.0 million in the aggregate with several correspondent banks. As of June 30, 2024, there was no balance outstanding related to these unsecured lines of credit. The Bank is a member of the AFX, through which it may either borrow or lend funds on an overnight or short-term basis with a group of pre-approved commercial banks. The availability of funds changes daily. As of June 30, 2024, there was no outstanding balance through the AFX.

The following tables provide a summary of the Bank’s primary and secondary liquidity levels at the dates indicated:

(Dollars in thousands)

(In thousands)

During the six months ended June 30, 2024, the Company's primary liquidity decreased by $721.2 million to $4.8 billion at June 30, 2024 due mainly to a $2.7 billion decrease in interest-earning deposits in financial institutions, offset partially by a decrease of $2.1 billion in pledged AFS securities. During the six months ended June 30, 2024, the Company's secondary liquidity increased by $345.9 million to $12.3 billion at June 30, 2024 due mainly to an increase in available secured borrowing capacity with the FHLB of $669.4 million, offset partially by a decrease in available secured borrowing capacity with the FRB of $323.6 million.

Obtaining new customer deposits, or having existing customers increase their deposit balances with us, are the primary sources of funding for our operations and is one the highest priorities of the Company. See "- Balance Sheet Analysis - Deposits" for additional information and detail of our deposits. Additionally, we fund our operations with cash flows from our loan and securities portfolios.

Our deposit balances may decrease if customers withdraw funds from the Bank. In order to address the Bank’s liquidity risk from fluctuating deposit balances, the Bank maintains adequate levels of available liquidity on and off the balance sheet.

We use brokered deposits, the availability of which is uncertain and subject to competitive market forces and regulation, for liquidity management purposes. At June 30, 2024, brokered deposits totaled $4.5 billion, consisting of $449.5 million of non-maturity brokered accounts and $4.0 billion of brokered time deposits. At December 31, 2023, brokered deposits totaled $4.6 billion, consisting of $1.1 billion of non-maturity brokered accounts and $3.5 billion of brokered time deposits.

Our liquidity policy includes guidelines, which are governed by the Company's Risk Appetite Statement, which include the following metrics: Primary Liquidity Ratio (unencumbered liquid assets and the market value of unpledged AFS securities, net of a haircut, divided by total assets), Brokered Deposits to Total Funding Ratio (wholesale deposits to total deposits plus borrowings), Total Borrowings to Total Funding Ratio (borrowings to total deposits and borrowings), Short-Term Non-Core Funding Ratio (retail time deposits of $250,000 or more that mature within one year, brokered deposits that mature within one year, listing service deposits that mature within one year, official checks, escrow and title company deposits, 1031 exchange accommodator deposits, Federal Funds purchased, and borrowings that mature within one year as a percentage of total assets) and the Wholesale Funding Ratio (wholesale deposits to total deposits and borrowings). At June 30, 2024, the Bank was in compliance with all of its funding concentration liquidity guidelines.

Holding Company Liquidity

Banc of California, Inc. acts as a source of financial strength for the Bank which can also include being a source of liquidity. The primary sources of liquidity for the holding company include dividends from the Bank, intercompany tax payments from the Bank, and Banc of California, Inc.'s ability to raise capital, issue subordinated debt, and secure outside borrowings. Banc of California, Inc.'s ability to obtain funds for the payment of dividends to our stockholders, the repurchase of shares of common stock, and other cash requirements is largely dependent upon the Bank’s earnings. The Bank is subject to restrictions under certain federal and state laws and regulations that limit its ability to transfer funds to the holding company through intercompany loans, advances, or cash dividends. Banc of California, Inc.'s ability to pay dividends is also subject to the restrictions set forth by the FRB, and by certain covenants contained in our subordinated debt. See "-Regulatory Matters - Dividend on Preferred Stock" for information regarding the payment of dividends on the Series F preferred stock.

At June 30, 2024, Banc of California, Inc. had $189.0 million in cash and cash equivalents, of which a substantial amount was on deposit at the Bank. We believe this amount of cash, along with anticipated future dividends from the Bank, will be sufficient to fund the holding company’s cash flow needs over the next 12 months.

Our obligations also include off-balance sheet arrangements consisting of loan commitments, of which only a portion is expected to be funded, and standby letters of credit. At June 30, 2024, our loan commitments and standby letters of credit were $5.3 billion and $209.9 million. The loan commitments, a portion of which will eventually result in funded loans, increase our profitability through net interest income when drawn and unused commitment fees prior to being drawn. We manage our overall liquidity taking into consideration funded and unfunded commitments as a percentage of our liquidity sources. Our liquidity sources, as described in "- Liquidity - Liquidity Management," have been and are expected to be sufficient to meet the cash requirements of our lending activities. For further information on loan commitments, see Note 11. Commitments and Contingencies, of our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

This analysis should be read in conjunction with text under the caption "Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K for the year ended December 31, 2023, which text is incorporated herein by reference. Our analysis of market risk and market-sensitive financial information contains forward-looking statements and is subject to the disclosure at the beginning of Item 2 regarding such forward-looking information.

Market Risk - Foreign Currency Exposure

We enter into foreign exchange contracts with our clients and counterparty banks primarily for the purpose of offsetting or hedging clients' foreign currency exposures arising out of commercial transactions, and we enter into cross currency swaps and foreign exchange contracts to hedge exposures to loans and debt instruments denominated in foreign currencies. We have experienced and will continue to experience fluctuations in our net earnings as a result of transaction gains or losses related to revaluing certain asset and liability balances that are denominated in currencies other than the U.S. Dollar and the derivatives that hedge those exposures. As of June 30, 2024, the U.S. Dollar notional amounts of loans receivable and subordinated debt payable denominated in foreign currencies were $8.6 million and $27.6 million, and the U.S. Dollar notional amounts of derivatives outstanding to hedge these foreign currency exposures were $8.6 million and $28.5 million. We recognized a foreign currency translation net loss of $355,000 for the six months ended June 30, 2024 and a foreign currency translation net gain of $170,000 for the six months ended June 30, 2023.

Asset/Liability Management and Interest Rate Sensitivity

Interest Rate Risk - Company Governance. On a monthly basis, we measure our IRR position using two methods: (i) Net Interest Income ("NII") simulation analysis and (ii) Economic Value of Equity ("EVE") modeling. The Management Finance Committee ("MFC") and the Finance Committee of the Company's Board of Directors review the results of these analyses at least quarterly. As discussed in more detail below, if projected changes to interest rates cause changes to our simulated net present value of equity and/or net interest income to be outside our pre-established IRR limits, we may adjust our asset and liability mix in an effort to bring our interest rate risk exposure within our established limits.

The pre-established IRR Limits are recommended by management, determined based on analytical review and available peer data published by regulatory agencies about the IRR Limits utilized by other regional banks, and documented in the Company's ALCO Policy. The ALCO Policy is approved by MFC and the Finance Committee of the Board of Directors annually. We believe our ALCO Policy IRR Limits are consistent with prevailing practice in the regional banking industry.

We use a balance sheet simulation model (the "IRR Model") to estimate changes in NII and EVE that would result from immediate and sustained changes in interest rates as of the measurement date. This IRR Model assesses the changes in NII and EVE that would occur in response to an instantaneous and sustained increase and decrease in market interest rates of +-100, +-200, +-300, and +400 basis points. This model is an IRR management tool, and the results are not necessarily an indication of our future net interest income. The IRR Model has inherent limitations and the model's results are based on a given set of rate changes and assumptions at a single point in time.

The IRR Model is updated monthly and the IRR Model results are reported to MFC and the Finance Committee of the Company's Board of Directors at each monthly or quarterly meeting, as applicable.

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

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

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

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

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

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

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

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

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

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

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

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

We used a NII simulation model to measure the estimated changes in NII that would result over the next twelve months from immediate and sustained changes in interest rates as of March 31, 2024. We have assumed no growth or changes in the product mix of either our total interest-sensitive assets or liabilities over the next twelve months, therefore the results reflect an interest rate shock to a static balance sheet. This model is an interest rate risk management tool and the results are not necessarily an indication of our future net interest income.

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

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

At June 30, 2024, our interest rate risk profile is “liability sensitive,” but less liability sensitive as compared to our interest rate risk profile position as of December 31, 2023. This shift is primarily due to the change in the mix of funding sources during the six months ended June 30, 2024 resulting from the paydowns of the Bank Term Funding Program balances. Given the uncertainty of the magnitude, timing, and direction of future interest rate movements, as well as the shape of the yield curve, actual results may vary materially from those predicted by our model.

The following table presents the projected change in the Company’s economic value of equity at June 30, 2024 and net interest income over the next twelve months, that would occur upon an immediate change in interest rates, but without giving effect to any steps that management might take to counteract that change:

(Dollars in millions)

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

(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer have evaluated our disclosure controls and procedures as of June 30, 2024 and have concluded that these disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file or submit is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b) Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting that occurred during the second quarter of 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

For information regarding factors that could affect the Company's results of operations, financial condition, and liquidity, see the risk factors disclosed in the "Risk Factors" section of our Annual Report on Form 10-K for the year ended December 31, 2023. See also "Forward-Looking Information" disclosed in Part I, Item 2 of this Quarterly Report on Form 10-Q.