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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2024
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 001-40379
FIVE STAR BANCORP
(Exact name of Registrant as specified in its charter) | | | | | | | | |
California | | 75-3100966 |
(State or other jurisdiction of incorporation or organization) | | (IRS Employer Identification No.) |
3100 Zinfandel Drive, Suite 100 Rancho Cordova, CA 95670
(Address of principal executive office) (Zip Code)
Registrant’s telephone number, including area code: (916) 626-5000
Securities registered pursuant to 12(b) of the Act: | | | | | | | | |
Title of each class | Trading symbol | Name of each exchange on which registered |
Common stock, no par value per share | FSBC | The Nasdaq Stock Market LLC |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. | | | | | | | | | | | |
Large accelerated filer | o | Accelerated filer | x |
Non-accelerated filer | o | Smaller reporting company | o |
Emerging growth company | x | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
As of November 4, 2024, there were 21,319,083 shares of the registrant’s common stock, no par value, outstanding.
TABLE OF CONTENTS
FIVE STAR BANCORP AND SUBSIDIARY
Quarterly Report on Form 10-Q
September 30, 2024
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIVE STAR BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
| | | | | | | | | | | | | | |
(in thousands, except share amounts) | | September 30, 2024 | | December 31, 2023 |
ASSETS | | | | |
Cash and due from financial institutions | | $ | 44,531 | | | $ | 26,986 | |
Interest-bearing deposits in banks | | 206,321 | | | 294,590 | |
Cash and cash equivalents | | 250,852 | | | 321,576 | |
Time deposits in banks | | 4,118 | | | 5,858 | |
Securities available-for-sale, at fair value, net of allowance for credit losses of $0 at September 30, 2024 and December 31, 2023 (amortized cost of $118,053 and $124,788 at September 30, 2024 and December 31, 2023, respectively) | | 104,238 | | | 108,083 | |
Securities held-to-maturity, at amortized cost, net of allowance for credit losses of $20 at September 30, 2024 and December 31, 2023 (fair value of $2,643 and $2,913 at September 30, 2024 and December 31, 2023, respectively) | | 2,720 | | | 3,077 | |
Loans held for sale | | 2,910 | | | 11,464 | |
Loans held for investment | | 3,460,565 | | | 3,081,719 | |
Allowance for credit losses | | (37,583) | | | (34,431) | |
Loans held for investment, net of allowance for credit losses | | 3,422,982 | | | 3,047,288 | |
FHLB stock | | 15,000 | | | 15,000 | |
Operating leases, right-of-use asset, net | | 6,590 | | | 5,284 | |
Premises and equipment, net | | 1,657 | | | 1,623 | |
Bank-owned life insurance | | 19,192 | | | 17,180 | |
Interest receivable and other assets | | 56,745 | | | 56,692 | |
Total assets | | $ | 3,887,004 | | | $ | 3,593,125 | |
| | | | |
LIABILITIES AND SHAREHOLDERS’ EQUITY | | | | |
Deposits: | | | | |
Non-interest-bearing | | $ | 906,939 | | | $ | 831,101 | |
Interest-bearing | | 2,493,040 | | | 2,195,795 | |
Total deposits | | 3,399,979 | | | 3,026,896 | |
Borrowings: | | | | |
Subordinated notes, net | | 73,859 | | | 73,749 | |
Other borrowings | | — | | | 170,000 | |
Operating lease liability | | 7,101 | | | 5,603 | |
Interest payable and other liabilities | | 16,135 | | | 31,103 | |
Total liabilities | | 3,497,074 | | | 3,307,351 | |
Commitments and contingencies (Note 8) | | | | |
Shareholders’ equity: | | | | |
Preferred stock, no par value; 10,000,000 shares authorized; zero issued and outstanding at September 30, 2024 and December 31, 2023 | | — | | | — | |
Common stock, no par value; 100,000,000 shares authorized; 21,319,583 shares issued and outstanding at September 30, 2024; 17,256,989 shares issued and outstanding at December 31, 2023 | | 302,251 | | | 220,505 | |
Retained earnings | | 97,411 | | | 77,036 | |
Accumulated other comprehensive loss, net of taxes | | (9,732) | | | (11,767) | |
Total shareholders’ equity | | 389,930 | | | 285,774 | |
Total liabilities and shareholders’ equity | | $ | 3,887,004 | | | $ | 3,593,125 | |
See accompanying notes to the unaudited consolidated financial statements.
FIVE STAR BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands, except per share amounts) | | 2024 | | 2023 | | 2024 | | 2023 |
Interest and fee income: | | | | | | | | |
Loans, including fees | | $ | 50,390 | | | $ | 41,861 | | | $ | 140,538 | | | $ | 119,284 | |
Taxable securities | | 445 | | | 472 | | | 1,396 | | | 1,401 | |
Nontaxable securities | | 175 | | | 181 | | | 527 | | | 548 | |
Interest-bearing deposits in banks | | 1,657 | | | 2,584 | | | 6,745 | | | 6,969 | |
Total interest and fee income | | 52,667 | | | 45,098 | | | 149,206 | | | 128,202 | |
| | | | | | | | |
Interest expense: | | | | | | | | |
Deposits | | 21,076 | | | 16,386 | | | 59,304 | | | 39,733 | |
Subordinated notes | | 1,161 | | | 1,161 | | | 3,484 | | | 3,484 | |
Other borrowings | | 44 | | | 75 | | | 196 | | | 783 | |
Total interest expense | | 22,281 | | | 17,622 | | | 62,984 | | | 44,000 | |
| | | | | | | | |
Net interest income | | 30,386 | | | 27,476 | | | 86,222 | | | 84,202 | |
Provision for credit losses | | 2,750 | | | 1,050 | | | 5,650 | | | 3,200 | |
Net interest income after provision for credit losses | | 27,636 | | | 26,426 | | | 80,572 | | | 81,002 | |
| | | | | | | | |
Non-interest income: | | | | | | | | |
Service charges on deposit accounts | | 165 | | | 158 | | | 542 | | | 410 | |
| | | | | | | | |
Gain on sale of loans | | 306 | | | 396 | | | 1,124 | | | 1,635 | |
Loan-related fees | | 406 | | | 355 | | | 1,205 | | | 1,052 | |
FHLB stock dividends | | 327 | | | 274 | | | 988 | | | 656 | |
Earnings on BOLI | | 162 | | | 127 | | | 462 | | | 355 | |
Other | | 15 | | | 74 | | | 466 | | | 1,467 | |
Total non-interest income | | 1,381 | | | 1,384 | | | 4,787 | | | 5,575 | |
| | | | | | | | |
Non-interest expense: | | | | | | | | |
Salaries and employee benefits | | 7,969 | | | 6,876 | | | 23,349 | | | 19,915 | |
Occupancy and equipment | | 626 | | | 561 | | | 1,898 | | | 1,635 | |
Data processing and software | | 1,327 | | | 1,020 | | | 3,719 | | | 2,905 | |
FDIC insurance | | 405 | | | 375 | | | 1,195 | | | 1,187 | |
Professional services | | 830 | | | 700 | | | 2,304 | | | 1,917 | |
Advertising and promotional | | 584 | | | 535 | | | 1,659 | | | 1,686 | |
Loan-related expenses | | 292 | | | 345 | | | 886 | | | 924 | |
Other operating expenses | | 1,743 | | | 1,603 | | | 4,995 | | | 4,943 | |
Total non-interest expense | | 13,776 | | | 12,015 | | | 40,005 | | | 35,112 | |
| | | | | | | | |
Income before provision for income taxes | | 15,241 | | | 15,795 | | | 45,354 | | | 51,465 | |
| | | | | | | | |
Provision for income taxes | | 4,300 | | | 4,750 | | | 13,000 | | | 14,530 | |
| | | | | | | | |
Net income | | $ | 10,941 | | | $ | 11,045 | | | $ | 32,354 | | | $ | 36,935 | |
| | | | | | | | |
Basic earnings per common share | | $ | 0.52 | | | $ | 0.64 | | | $ | 1.63 | | | $ | 2.15 | |
Diluted earnings per common share | | $ | 0.52 | | | $ | 0.64 | | | $ | 1.63 | | | $ | 2.15 | |
See accompanying notes to unaudited consolidated financial statements.
FIVE STAR BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
(in thousands) | | 2024 | | 2023 | | 2024 | | 2023 |
Net income | | $ | 10,941 | | | $ | 11,045 | | | $ | 32,354 | | | $ | 36,935 | |
| | | | | | | | |
Unrealized gain (loss) on securities: | | | | | | | | |
Net unrealized holding gain (loss) on securities available-for-sale during the period | | 3,549 | | | (4,195) | | | 2,889 | | | (3,516) | |
| | | | | | | | |
Less: Income tax expense (benefit) related to items of other comprehensive income (loss) | | 1,049 | | | (1,240) | | | 854 | | | (1,039) | |
Other comprehensive income (loss) | | 2,500 | | | (2,955) | | | 2,035 | | | (2,477) | |
| | | | | | | | |
Total comprehensive income | | $ | 13,441 | | | $ | 8,090 | | | $ | 34,389 | | | $ | 34,458 | |
See accompanying notes to the unaudited consolidated financial statements.
FIVE STAR BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the Three Months Ended September 30, 2024 and 2023
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Common Stock | | Retained Earnings | | Accumulated Other Comprehensive Loss | | Total Shareholders’ Equity |
(in thousands, except per share amounts) | | Shares | | Amount | | | |
Balance at June 30, 2023 | | 17,257,357 | | | $ | 220,021 | | | $ | 62,095 | | | $ | (12,976) | | | $ | 269,140 | |
| | | | | | | | | | |
Net income | | — | | | — | | | 11,045 | | | — | | | 11,045 | |
Other comprehensive loss | | — | | | — | | | — | | | (2,955) | | | (2,955) | |
| | | | | | | | | | |
Stock compensation expense | | — | | | 245 | | | — | | | — | | | 245 | |
| | | | | | | | | | |
Cash dividends paid ($0.20 per share) | | — | | | — | | | (3,451) | | | — | | | (3,451) | |
Balance at September 30, 2023 | | 17,257,357 | | | $ | 220,266 | | | $ | 69,689 | | | $ | (15,931) | | | $ | 274,024 | |
| | | | | | | | | | |
Balance at June 30, 2024 | | 21,319,583 | | | $ | 301,968 | | | $ | 90,734 | | | $ | (12,232) | | | $ | 380,470 | |
Net income | | — | | | — | | | 10,941 | | | — | | | 10,941 | |
Other comprehensive income | | — | | | — | | | — | | | 2,500 | | | 2,500 | |
| | | | | | | | | | |
| | | | | | | | | | |
Stock compensation expense | | — | | | 283 | | | — | | | — | | | 283 | |
| | | | | | | | | | |
Cash dividends paid ($0.20 per share) | | — | | | — | | | (4,264) | | | — | | | (4,264) | |
Balance at September 30, 2024 | | 21,319,583 | | | $ | 302,251 | | | $ | 97,411 | | | $ | (9,732) | | | $ | 389,930 | |
See accompanying notes to the unaudited consolidated financial statements.
FIVE STAR BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the Nine Months Ended September 30, 2024 and 2023
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Common Stock | | Retained Earnings | | Accumulated Other Comprehensive Loss | | Total Shareholders’ Equity |
(in thousands, except per share amounts) | | Shares | | Amount | | | |
Balance at December 31, 2022 | | 17,241,926 | | | $ | 219,543 | | | $ | 46,736 | | | $ | (13,454) | | | $ | 252,825 | |
Cumulative effect of adoption of ASC 326 on retained earnings | | — | | | — | | | (4,491) | | | — | | | (4,491) | |
Net income | | — | | | — | | | 36,935 | | | — | | | 36,935 | |
Other comprehensive loss | | — | | | — | | | — | | | (2,477) | | | (2,477) | |
Stock issued under stock award plans | | 16,978 | | | — | | | — | | | — | | | — | |
Stock compensation expense | | — | | | 723 | | | — | | | — | | | 723 | |
Stock forfeitures | | (1,547) | | | — | | | — | | | — | | | — | |
Cash dividends paid ($0.55 per share) | | — | | | — | | | (9,491) | | | — | | | (9,491) | |
Balance at September 30, 2023 | | 17,257,357 | | | $ | 220,266 | | | $ | 69,689 | | | $ | (15,931) | | | $ | 274,024 | |
| | | | | | | | | | |
Balance at December 31, 2023 | | 17,256,989 | | | $ | 220,505 | | | $ | 77,036 | | | $ | (11,767) | | | $ | 285,774 | |
Net income | | — | | | — | | | 32,354 | | | — | | | 32,354 | |
Other comprehensive income | | — | | | — | | | — | | | 2,035 | | | 2,035 | |
Common stock issued | | 3,967,500 | | | 80,870 | | | — | | | — | | | 80,870 | |
Stock issued under stock award plans | | 96,380 | | | — | | | — | | | — | | | — | |
Stock compensation expense | | — | | | 876 | | | — | | | — | | | 876 | |
Stock forfeitures | | (1,286) | | | — | | | — | | | — | | | — | |
Cash dividends paid ($0.60 per share) | | — | | | — | | | (11,979) | | | — | | | (11,979) | |
Balance at September 30, 2024 | | 21,319,583 | | | $ | 302,251 | | | $ | 97,411 | | | $ | (9,732) | | | $ | 389,930 | |
See accompanying notes to unaudited consolidated financial statements.
FIVE STAR BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
(in thousands) | | 2024 | | 2023 |
Cash flows from operating activities: | | | | |
Net income | | $ | 32,354 | | | $ | 36,935 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | |
Provision for credit losses | | 5,650 | | | 3,200 | |
Depreciation and amortization | | 1,407 | | | 1,227 | |
Amortization of deferred loan fees and costs | | (272) | | | 125 | |
Amortization of premiums and discounts on securities | | 721 | | | 886 | |
Amortization of subordinated note issuance costs | | 109 | | | 107 | |
Stock compensation expense | | 876 | | | 723 | |
Earnings on BOLI | | (462) | | | (355) | |
Deferred tax provision | | 24 | | | 79 | |
Loans originated for sale | | (19,358) | | | (39,915) | |
Gain on sale of loans | | (1,124) | | | (1,635) | |
Gross proceeds from sale of loans | | 17,572 | | | 32,224 | |
| | | | |
Gain on partial sale of equity investment | | (242) | | | (1,274) | |
Net changes in: | | | | |
Interest receivable and other assets | | 1,459 | | | (5,523) | |
Interest payable and other liabilities | | (4,195) | | | 14,457 | |
Operating lease liability | | (727) | | | (714) | |
Net cash provided by operating activities | | 33,792 | | | 40,547 | |
Cash flows from investing activities: | | | | |
| | | | |
Maturities, prepayments, and calls of securities available-for-sale | | 6,370 | | | 8,134 | |
| | | | |
Capital call for equity investment | | (2,802) | | | — | |
Proceeds received from equity investment | | 530 | | | — | |
Low income housing tax credits | | (10,559) | | | — | |
Net change in time deposits in banks | | 1,740 | | | 2,878 | |
Loan originations, net of repayments | | (369,697) | | | (212,137) | |
Purchase of premises and equipment | | (522) | | | (470) | |
Purchase of FHLB stock | | — | | | (4,110) | |
Purchase of BOLI | | (1,550) | | | (2,000) | |
Net cash used in investing activities | | (376,490) | | | (207,705) | |
Cash flows from financing activities: | | | | |
Net change in deposits | | 373,083 | | | 250,206 | |
Proceeds from issuance of stock, net of issuance costs | | 80,870 | | | — | |
Payments on other borrowings | | (170,000) | | | (10,000) | |
Cash dividends paid | | (11,979) | | | (9,491) | |
| | | | |
| | | | |
Net cash provided by financing activities | | 271,974 | | | 230,715 | |
Net change in cash and cash equivalents | | (70,724) | | | 63,557 | |
Cash and cash equivalents at beginning of period | | 321,576 | | | 259,991 | |
Cash and cash equivalents at end of period | | $ | 250,852 | | | $ | 323,548 | |
| | | | |
Supplemental disclosure of cash flow information: | | | | |
Interest paid | | $ | 65,223 | | | $ | 43,817 | |
Income taxes paid | | 11,388 | | | 1,480 | |
Supplemental disclosure of noncash items: | | | | |
Transfer from loans held for sale to loans held for investment | | 11,464 | | | 9,416 | |
Unrealized gain (loss) on securities | | 2,889 | | | (3,516) | |
Operating lease liabilities exchanged for ROUA | | 2,225 | | | 1,513 | |
ROUA acquired | | (2,225) | | | (1,534) | |
See accompanying notes to the unaudited consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1: Basis of Presentation and Summary of Significant Accounting Policies
(a) Organization
Five Star Bank (the “Bank”) was chartered on October 26, 1999 and began operations on December 20, 1999. Five Star Bancorp (“Bancorp” or the “Company”) was incorporated on September 16, 2002 and subsequently obtained approval from the Federal Reserve to become a bank holding company in connection with its acquisition of the Bank. The Company became the sole shareholder of the Bank on June 2, 2003 in a statutory merger, pursuant to which each outstanding share of the Bank’s common stock was exchanged for one share of common stock of the Company.
The Company, through the Bank, provides financial services to customers who are predominately small and middle-market businesses, professionals, and individuals residing in the Northern California region. The Company’s primary loan products are commercial real estate loans, land development loans, construction loans, and operating lines of credit, and its primary deposit products are checking accounts, savings accounts, money market accounts, and term certificate accounts. The Bank currently has eight branch offices in Roseville, Natomas, Rancho Cordova, Redding, Elk Grove, Chico, Yuba City, and San Francisco.
(b) Basis of Financial Statement Presentation and Consolidation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as contained within the Financial Accounting Standards Board’s (“FASB”) ASC and the rules and regulations of the SEC, including the instructions to Regulation S-X. These interim unaudited consolidated financial statements reflect all adjustments (consisting solely of normal recurring adjustments and accruals) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and comprehensive income, changes in shareholders’ equity, and cash flows for the interim periods presented. These unaudited consolidated financial statements have been prepared on a basis consistent with, and should be read in conjunction with, the audited consolidated financial statements as of and for the year ended December 31, 2023, and the notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 (the “2023 Annual Report on Form 10-K”), which was filed with the SEC on February 23, 2024.
The unaudited consolidated financial statements include Bancorp and its wholly owned subsidiary, the Bank. All significant intercompany transactions and balances are eliminated in consolidation.
The results of operations for the three and nine months ended September 30, 2024 are not necessarily indicative of the results of operations that may be expected for any other interim period or for the year ending December 31, 2024.
The Company’s accounting and reporting policies conform to GAAP and to general practices within the banking industry.
(c) Segments
While the Company’s chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Discrete financial information is not available other than on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
(d) Emerging Growth Company
The Company qualifies as an emerging growth company as defined in the Jumpstart Our Business Startups Act of 2012, and, as such, may take advantage of specified reduced reporting requirements and deferred accounting standards adoption dates, and is relieved of other significant requirements that are otherwise generally applicable to other public companies. The Company will remain an emerging growth company for five years after its IPO date of May 5, 2021, unless one of the following occurs: (i) total annual gross revenues are $1.235 billion or more; (ii) the Company issues more than $1.0 billion in non-convertible debt; or (iii) the Company becomes a large accelerated filer with a public float of more than $0.7 billion.
(e) Significant Accounting Policies
The Company’s significant accounting policies are included in Note 1, Basis of Presentation in the notes to our audited consolidated financial statements included in the 2023 Annual Report on Form 10-K.
(f) Recently Issued Accounting Standards
The following information reflects recent accounting standards that have been adopted or are pending adoption by the Company. The Company qualifies as an emerging growth company and, as such, has elected to use the extended transition period for complying with new or revised accounting standards and is not subject to the new or revised accounting standards applicable to public companies during the extended transition period. The accounting standards discussed below indicate effective dates for the Company as an emerging growth company using the extended transition period.
Accounting Standards Adopted in 2024
In March 2023, the FASB issued ASU 2023-02, Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (“ASU 2023-02”). Under current GAAP, an entity can only elect to apply the proportional amortization method to investments in low income housing tax credit (“LIHTC”) structures. The amendments in ASU 2023-02 allow entities to elect to account for equity investments made primarily for the purpose of receiving income tax credits using the proportional amortization method, regardless of the tax credit program through which the investment earns income tax credits, if certain conditions are met. ASU 2023-02 provides amendments to paragraph ASC 323-740-25-1, which sets forth the conditions needed to apply the proportional amortization method. The amendments make certain limited changes to those conditions to clarify their application to a broader group of tax credit investment programs. However, the conditions in substance remain consistent with current GAAP. The amendments in ASU 2023-02 also eliminate certain LIHTC-specific guidance to align the accounting more closely with the accounting for other equity investments in tax credit structures and require that the delayed equity contribution guidance in paragraph ASC 323-740-25-3 apply only to tax equity investments accounted for using the proportional amortization method. The Company adopted ASU 2023-02 on January 1, 2024, which did not have a significant impact on the Company’s consolidated financial statements.
Accounting Standards Issued But Not Yet Adopted
In October 2023, the FASB issued ASU No. 2023-06, Disclosure Improvements - Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative (“ASU 2023-06”), amending disclosure or presentation requirements related to various subtopics in the FASB’s ASC. ASU 2023-06 was issued in response to the SEC’s initiative to update and simplify disclosure requirements. The SEC identified 27 disclosure requirements that were incremental to those in the ASC and referred them to the FASB for potential incorporation into GAAP. To avoid duplication, the SEC intended to eliminate those disclosure requirements from existing SEC regulations as the FASB incorporated them into the relevant ASC subtopics. ASU 2023-06 adds 14 of the 27 identified disclosure or presentation requirements to the ASC. ASU 2023-06 is to be applied prospectively, and early adoption is prohibited. For reporting entities subject to the SEC’s existing disclosure requirements, the effective dates of ASU 2023-06 will be the date on which the SEC’s removal of that related disclosure requirement from Regulation S-X or Regulation S-K becomes effective. If by June 30, 2027, the SEC has not removed the applicable requirement from Regulation S-X or Regulation S-K, the pending content of the related amendment will be removed from the ASC and will not become effective for any entities. ASU 2023-06 is not expected to have a significant impact on the Company’s consolidated financial statements.
In November 2023, the FASB issued ASU No. 2023-07, Segment Reporting (Topic 280) - Improvements to Reportable Segment Disclosures (“ASU 2023-07”), amending disclosure requirements related to segment reporting primarily through enhanced disclosure about significant segment expenses and by requiring disclosure of segment information on an annual and interim basis. ASU 2023-07 is effective January 1, 2024 and for interim periods beginning after December 15, 2024. The key amendments: (i) require that a public entity disclose, on an annual and interim basis, significant segment expenses that are regularly provided to the chief operating decision maker (the “CODM”) and included within each reported measure of segment profit or loss; (ii) require that a public entity disclose, on an annual and interim basis, an amount for other segment items by reportable segment and a description of its composition; (iii) require that a public entity provide all annual disclosures about a reportable segment’s profit or loss currently required by GAAP in interim periods as well; (iv) clarify that if the CODM uses more than one measure of a segment’s profit or loss in assessing segment performance and deciding how to allocate resources, an entity may report one or more of those additional measures of segment profit; (v) require that a public entity disclose the title and position of the CODM and an explanation of how the CODM uses the
reported measure of segment profit or loss in assessing segment performance and deciding how to allocate resources; and (vi) require that a public entity that has a single reportable segment provide all the disclosures required by the amendments in the ASU and all existing segment disclosures. The requirements of this standard for such entities will apply beginning with the Company’s annual report for the year ending December 31, 2024. The Company has one reportable segment and ASU 2023-07 is not expected to have a significant impact on the Company’s consolidated financial statements.
In December 2023, the FASB issued ASU No. 2023-09, Income Taxes (Topic 740) - Improvements to Income Tax Disclosures (“ASU 2023-09”), which enhances the transparency and decision usefulness of income tax disclosures. ASU 2023-09 will require disaggregated information about a reporting entity’s effective tax rate reconciliation as well as information on income taxes paid. Entities will also be required to disclose income/(loss) from continuing operations before income tax expense/(benefit) disaggregated between domestic and foreign, as well as income tax expense/(benefit) from continuing operations disaggregated by federal, state, and foreign. ASU 2023-09 is effective January 1, 2025 and is not expected to have a significant impact on the Company’s consolidated financial statements.
In March 2024, the FASB issued ASU 2024-02, Codification Improvements - Amendments to Remove References to the Concepts Statements (“ASU 2024-02”). ASU 2024-02 contains amendments to the ASC that remove references to various Concepts Statements. In most instances, the references are extraneous and not required to understand or apply the guidance. In other instances, the references were used in prior Statements to provide guidance in certain topical areas. FASB Concepts Statements are nonauthoritative. Removing all references to Concepts Statements in the guidance is intended to simplify the ASC and draw a distinction between authoritative and nonauthoritative literature. ASU 2024-02 is effective January 1, 2025 and is not expected to have a significant impact on the Company’s consolidated financial statements.
(g) Allowance for Credit Losses (“ACL”)
The ACL is a valuation account that offsets the amortized cost basis of loans receivable and certain other financial assets, including unfunded loan commitments and held-to-maturity debt securities. Under ASC 326, amortized cost basis is the basis on which the ACL is determined. Amortized cost basis on loans receivable is principal outstanding, net of any purchase premiums and discounts, and net of any deferred loan fees and costs.
Credit losses are charged off when management believes that the collectability of at least some portion of outstanding principal is unlikely. These charge-offs are recorded as a reversal to, thereby reducing, the allowance for credit losses. Subsequent recoveries of previously charged-off amounts, if any, are recorded as a provision to, thereby increasing, the allowance for credit losses. The allowance for credit losses is maintained at a level to absorb expected credit losses over the contractual life, including consideration of prepayments. Determining the adequacy of the allowance is complex and requires judgments that are inherently subjective, as it requires estimates that are susceptible to revision as additional information becomes available. While the Company has determined an allowance for credit losses it considers appropriate, there can be no assurance that the allowance will be sufficient to absorb future losses.
The Company’s process for determining expected lifetime credit losses entails a loan-level, model-based approach and considers a broad range of information, including historical loss experience, current conditions, and reasonable and supportable forecasts. Credit loss is estimated for all loans. Accordingly, the Company has stratified the full loan population into segments sharing similar characteristics to perform the evaluation of the credit loss collectively. The Company can also further stratify loans of similar types, risk attributes, and methods for credit risk monitoring.
The Company has determined loan pools based primarily on regulatory reporting codes, as the loans within each pool share similar risk characteristics and there is sufficient historical peer loss data from the FFIEC to provide statistically meaningful support in the models developed. The Company further stratified the following portfolios as the loans in these pools have different repayment structures and credit risk characteristics: Multifamily portfolio into traditional Multifamily loans and Manufactured Home Community (“MHC”) loans, CRE Non-Owner Occupied portfolio into traditional CRE Non-Owner Occupied loans and RV Park loans, and C&I portfolio into traditional C&I loans and SBA loans. The Company also stratified C&I loans and consumer loans that do not require reserves, as the Company has third-party agreements in place to cover credit losses. The Company has identified the following pools subject to an estimate of credit loss: (1) 1-4 Family Construction; (2) Other Construction; (3) Farmland; (4) Revolving Secured by 1-4 Family; (5) Residential Secured by First Liens; (6) Residential Secured by Junior Liens; (7) Multifamily; (8) Multifamily MHC; (9) CRE Owner Occupied; (10) CRE Non-Owner Occupied; (11) CRE Non-Owner Occupied RV Park; (12) Agriculture; (13) C&I; (14) C&I SBA; (15) Consumer; and (16) Municipal.
With the exception of the C&I SBA pool, the Company has determined, given its limited loss experience, that peer data and other external data to support loss history provides the best basis for its assessment of expected credit losses. The Company believes that the use of peer loss data from March 31, 2004 through December 31, 2019 and January 31, 2022 through March 31, 2024 presents loss histories that appropriately reflect a full economic cycle, reflects asset-specific risk characteristics at each pool level identified, and includes a historical look-back period that is objective and reflective of future expected credit losses. Loss data from 2020 and beyond was excluded from the data set to exclude pandemic-related data from the model.
During the three months ended September 30, 2024, the Company segregated RV Park loans from the CRE Non-Owner Occupied portfolio, as the Company identified a data source to provide sufficient historical peer loss data specific to RV Park loans. This segregation now adjusts for differences in the risk characteristics and performance of RV Parks compared to standard CRE Non-Owner Occupied properties. The Company used calculations of individual probability of default and loss given default on a loan-by-loan basis to derive an estimated loss rate. This adjustment reduced the required reserves related to the RV Park pool by approximately $3.3 million.
The method for determining the estimate of lifetime credit losses includes, among other things, the following main components: (i) the use of probability of default and loss given default assumptions under a discounted cash flow model; (ii) a multi-scenario macroeconomic forecast; (iii) an initial and reasonable and supportable forecast period of one year for all loan segments; and (iv) a reversion period of one year using a linear transition method to historical loss rates.
Given the inherent limitations of a quantitative-only model, qualitative adjustments are included to factor in data points not captured from a quantitative analysis alone.
Qualitative criteria that can be considered includes, among other things, the following:
•Concentrations – the existence and effect of any concentrations of credit, and changes in the level of such concentrations;
•Volume – changes in the nature and volume of the portfolio and in the terms of the loans;
•Economic – changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;
•Policy – changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;
•Quality – changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans; and
•External – the effect of other external factors, such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s loan portfolio.
Management reviews current information on a quarterly basis to assess the forecasted future economic impact for purposes of evaluating the adequacy of the ACL. The forecasted direction and magnitude of change with respect to future economic conditions is then assessed against the estimate in the model. Any changes resulting from the quarterly assessment are recorded in “Provision for credit losses” in the unaudited consolidated statements of income. The Audit Committee of the board of directors reviews the adequacy of the allowance at least quarterly.
Accrued interest receivable is excluded from amortized cost of all financial instrument types and included in “Interest receivable and other assets” in the consolidated balance sheets. Accrued interest receivable is not subject to an estimate for credit loss, as the Company has a policy to charge off accrued interest deemed uncollectible in a timely manner. When a loan is placed on non-accrual status, which occurs within 90 days of a borrower becoming delinquent, interest previously accrued but not collected is reversed against current period income.
If an individual loan’s characteristics have deteriorated to below a range of the overall pool, the loan would be individually assessed. Individually assessed loans are measured for credit loss based on one of the following methods: (i) present value of future expected cash flows, discounted at the loan’s effective interest rate; (ii) amount by which carrying value of the loan exceeds the loan’s observable market price; or (iii) the fair value of the collateral, less estimated selling costs, if the loan is collateral dependent. The Company applies the practical expedient and defines collateral dependent loans as those where the borrower is experiencing financial difficulty and on which payment is expected to be provided substantially through the operation or sale of the collateral.
Note 2: Fair Value of Assets and Liabilities
Fair Value Hierarchy and Fair Value Measurement
Accounting standards require the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The fair values of securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
Table 2.1 summarizes the Company’s assets and liabilities required to be recorded at fair value on a recurring basis.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Table 2.1: Fair Value on a Recurring Basis |
(in thousands) | | Carrying Value | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Measurement Categories: Changes in Fair Value Recorded In |
September 30, 2024 | | | | | | | | | | |
Assets: | | | | | | | | | | |
Securities available-for-sale: | | | | | | | | | | |
U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions, collateralized mortgage obligations, and corporate bonds | | $ | 104,238 | | | $ | — | | | $ | 104,238 | | | $ | — | | | OCI |
Derivatives – interest rate swap | | — | | | — | | | — | | | — | | | NI |
Liabilities: | | | | | | | | | | |
Derivatives – interest rate swap | | — | | | — | | | — | | | — | | | NI |
| | | | | | | | | | |
December 31, 2023 | | | | | | | | | | |
Assets: | | | | | | | | | | |
Securities available-for-sale: | | | | | | | | | | |
U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions, collateralized mortgage obligations, and corporate bonds | | $ | 108,083 | | | $ | — | | | $ | 108,083 | | | $ | — | | | OCI |
Derivatives – interest rate swap | | 10 | | | — | | | 10 | | | — | | | NI |
Liabilities: | | | | | | | | | | |
Derivatives – interest rate swap | | 10 | | | — | | | 10 | | | — | | | NI |
Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1 inputs) are used to determine the fair value of available-for-sale securities. If quoted market prices are not available,
management obtains pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity, and credit spreads (Level 2 inputs). Level 2 securities include U.S. agencies’ or government-sponsored agencies’ debt securities, mortgage-backed securities, government agency-issued bonds, privately issued collateralized mortgage obligations, and corporate bonds. Level 3 securities are based on unobservable inputs that are supported by little or no market activity. In addition, values use discounted cash flow models and may include significant management judgment and estimation. As of September 30, 2024 and December 31, 2023, there were no Level 1 available-for-sale securities and no transfers between Level 1 and Level 2 classifications for assets or liabilities measured at fair value on a recurring basis.
On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both the Company’s credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made when collateral posted by the counterparty does not fully cover their liability to the Company. There was no carrying value or fair value for interest rate swaps as of September 30, 2024.
Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as collateral dependent loans and other real estate owned. As of September 30, 2024 and December 31, 2023, the carrying amount of assets measured at fair value on a non-recurring basis was immaterial to the Company.
Disclosures about Fair Value of Financial Instruments
Table 2.2 is a summary of fair value estimates for financial instruments as of September 30, 2024 and December 31, 2023. The carrying amounts in Table 2.2 are recorded in the consolidated balance sheets under the indicated captions. Further, management has not disclosed the fair value of financial instruments specifically excluded from disclosure requirements, such as BOLI.
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Table 2.2: Fair Value Estimates for Financial Instruments |
| | September 30, 2024 | | December 31, 2023 |
(in thousands) | | Carrying Amounts | | Fair Value | | Fair Value Hierarchy | | Carrying Amounts | | Fair Value | | Fair Value Hierarchy |
Financial assets: | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 250,852 | | | $ | 250,852 | | | Level 1 | | $ | 321,576 | | | $ | 321,576 | | | Level 1 |
Time deposits in banks | | 4,118 | | | 4,118 | | | Level 1 | | 5,858 | | | 5,858 | | | Level 1 |
Securities available-for-sale | | 104,238 | | | 104,238 | | | Level 2 | | 108,083 | | | 108,083 | | | Level 2 |
Securities held-to-maturity | | 2,720 | | | 2,643 | | | Level 3 | | 3,077 | | | 2,913 | | | Level 3 |
Loans held for sale | | 2,910 | | | 3,222 | | | Level 2 | | 11,464 | | | 12,626 | | | Level 2 |
Loans held for investment, net of allowance for credit losses | | 3,422,982 | | | 3,317,617 | | | Level 3 | | 3,047,288 | | | 2,891,925 | | | Level 3 |
FHLB stock and other investments | | 24,112 | | | N/A | | N/A | | 21,801 | | | N/A | | N/A |
Interest rate swap | | — | | | — | | | Level 2 | | 10 | | | 10 | | | Level 2 |
Financial liabilities: | | | | | | | | | | | | |
Interest rate swap | | $ | — | | | $ | — | | | Level 2 | | $ | 10 | | | $ | 10 | | | Level 2 |
Time deposits | | 491,008 | | | 490,613 | | | Level 2 | | 466,572 | | | 465,205 | | | Level 2 |
Subordinated notes | | 73,859 | | | 73,335 | | | Level 3 | | 73,749 | | | 72,693 | | | Level 3 |
Other borrowings | | — | | | — | | | Level 2 | | 170,000 | | | 170,000 | | | Level 2 |
The Company used the following methods and assumptions to estimate the fair value of its financial instruments at September 30, 2024 and December 31, 2023:
Cash and cash equivalents and time deposits in banks: The carrying amount is estimated to be fair value due to the liquid nature of the assets and their short-term maturities.
Investment securities: See discussion above for the methods and assumptions used by the Company to estimate the fair value of investment securities. Fair value of held-to-maturity securities is estimated by calculating the net present value of future cash flows based on observable market data, such as interest rates and yield curves (observable at commonly quoted intervals) as provided by an independent third party.
Loans held for sale: The fair value is based on what secondary markets are currently offering for portfolios with similar characteristics.
Loans held for investment, net of allowance for credit losses: For variable rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, which use interest rates being offered at each reporting date for loans with similar terms to borrowers of comparable creditworthiness without considering widening credit spreads due to market illiquidity, which approximates the exit price notion. The allowance for credit losses is considered to be a reasonable estimate of loan discount for credit quality concerns.
FHLB stock and other investments: Carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and do not have a readily determinable market value.
Commitments to extend credit: These are primarily for adjustable rate loans, and there are no differences between the committed amounts and their fair values. Commitments to fund fixed rate loans are at rates which approximate fair value at each reporting date.
Time deposits: The fair value is estimated using a discounted cash flow analysis that uses interest rates offered at each reporting date by the Company for certificates with similar remaining maturities, resulting in a Level 2 classification.
Subordinated notes: The fair value is estimated by discounting the future cash flow using the current three-month CME Term SOFR. The Company’s subordinated notes are not registered securities and were issued through private placements, resulting in a Level 3 classification. The notes are recorded at carrying value.
Other borrowings: The carrying amount is estimated to be fair value.
Note 3: Investment Securities
The Company’s investment securities portfolio includes obligations of states and political subdivisions, securities issued by U.S. federal government agencies, such as the SBA, and securities issued by U.S. GSEs, such as the FNMA, the FHLMC, and the FHLB. The Company also invests in residential and commercial mortgage-backed securities, collateralized mortgage obligations issued or guaranteed by GSEs, and corporate bonds, as reflected in Tables 3.1 and 3.2.
A summary of the amortized cost and fair value related to securities held-to-maturity as of September 30, 2024 and December 31, 2023 is presented in Table 3.1. Securities held-to-maturity had a $20.0 thousand allowance for credit losses as of September 30, 2024 and December 31, 2023.
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Table 3.1: Securities Held-to-Maturity |
(in thousands) | | Amortized Cost | | Gross Unrealized | | Fair Value |
| | Gains | | (Losses) | |
September 30, 2024 | | | | | | | | |
Obligations of states and political subdivisions | | $ | 2,720 | | | $ | — | | | $ | (77) | | | $ | 2,643 | |
Total held-to-maturity | | $ | 2,720 | | | $ | — | | | $ | (77) | | | $ | 2,643 | |
December 31, 2023 | | | | | | | | |
Obligations of states and political subdivisions | | $ | 3,077 | | | $ | — | | | $ | (164) | | | $ | 2,913 | |
Total held-to-maturity | | $ | 3,077 | | | $ | — | | | $ | (164) | | | $ | 2,913 | |
For securities issued by states and political subdivisions, for purposes of evaluating whether to recognize credit loss expense, management considers: (i) issuer and/or guarantor credit ratings; (ii) historical probability of default and loss given default rates for given bond ratings and remaining maturity; (iii) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities; (iv) internal credit review of the financial information; and (v) whether or not such securities have credit enhancements such as guarantees, contain a defeasance clause, or are pre-refunded by the issuers.
A summary of the amortized cost and fair value related to securities available-for-sale as of September 30, 2024 and December 31, 2023 is presented in Table 3.2. Securities available-for-sale did not have an allowance for credit losses as of September 30, 2024 or December 31, 2023.
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Table 3.2: Securities Available-for-Sale |
(in thousands) | | Amortized Cost | | Gross Unrealized | | Fair Value |
| | Gains | | (Losses) | |
September 30, 2024 | | | | | | | | |
U.S. government agency securities | | $ | 8,807 | | | $ | 140 | | | $ | (82) | | | $ | 8,865 | |
Mortgage-backed securities | | 64,030 | | | 23 | | | (9,327) | | | 54,726 | |
Obligations of states and political subdivisions | | 42,895 | | | 6 | | | (4,421) | | | 38,480 | |
Collateralized mortgage obligations | | 321 | | | — | | | (20) | | | 301 | |
Corporate bonds | | 2,000 | | | — | | | (134) | | | 1,866 | |
Total available-for-sale | | $ | 118,053 | | | $ | 169 | | | $ | (13,984) | | | $ | 104,238 | |
December 31, 2023 | | | | | | | | |
U.S. government agency securities | | $ | 10,548 | | | $ | 142 | | | $ | (149) | | | $ | 10,541 | |
Mortgage-backed securities | | 68,585 | | | 7 | | | (11,619) | | | 56,973 | |
Obligations of states and political subdivisions | | 43,288 | | | 12 | | | (4,841) | | | 38,459 | |
Collateralized mortgage obligations | | 367 | | | — | | | (35) | | | 332 | |
Corporate bonds | | 2,000 | | | — | | | (222) | | | 1,778 | |
Total available-for-sale | | $ | 124,788 | | | $ | 161 | | | $ | (16,866) | | | $ | 108,083 | |
The amortized cost and fair value of investment securities by contractual maturity at September 30, 2024 and December 31, 2023 are shown in Table 3.3. Expected maturities may differ from contractual maturities if the issuers of the securities have the right to call or prepay obligations with or without call or prepayment penalties.
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Table 3.3: Contractual Maturities - Investment Securities |
(in thousands) | | September 30, 2024 | | December 31, 2023 |
| Held-to-Maturity | | Available-for-Sale | | Held-to-Maturity | | Available-for-Sale |
| Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
Within one year | | $ | 210 | | | $ | 204 | | | $ | — | | | $ | — | | | $ | 277 | | | $ | 263 | | | $ | — | | | $ | — | |
After one but within five years | | 945 | | | 918 | | | 802 | | | 756 | | | 935 | | | 885 | | | 394 | | | 367 | |
After five years through ten years | | 1,380 | | | 1,341 | | | 9,247 | | | 8,379 | | | 1,365 | | | 1,292 | | | 6,407 | | | 5,838 | |
After ten years | | 185 | | | 180 | | | 32,846 | | | 29,345 | | | 500 | | | 473 | | | 36,487 | | | 32,254 | |
| | | | | | | | | | | | | | | | |
Investment securities not due at a single maturity date: | | | | | | | | | | | | | | | | |
U.S. government agency securities | | — | | | — | | | 8,807 | | | 8,865 | | | — | | | — | | | 10,548 | | | 10,541 | |
Mortgage-backed securities | | — | | | — | | | 64,030 | | | 54,726 | | | — | | | — | | | 68,585 | | | 56,973 | |
Collateralized mortgage obligations | | — | | | — | | | 321 | | | 301 | | | — | | | — | | | 367 | | | 332 | |
Corporate bonds | | — | | | — | | | 2,000 | | | 1,866 | | | — | | | — | | | 2,000 | | | 1,778 | |
Total | | $ | 2,720 | | | $ | 2,643 | | | $ | 118,053 | | | $ | 104,238 | | | $ | 3,077 | | | $ | 2,913 | | | $ | 124,788 | | | $ | 108,083 | |
There were no purchases or sales of investment securities during the three and nine months ended September 30, 2024 and September 30, 2023.
Pledged investment securities are shown in Table 3.4.
| | | | | | | | | | | | | | |
Table 3.4: Pledged Investment Securities |
(in thousands) | | September 30, 2024 | | December 31, 2023 |
Pledged to: | | | | |
The State of California, securing deposits of public funds and borrowings | | $ | 53,377 | | | $ | 55,435 | |
The Federal Reserve Discount Window, increasing borrowing capacity | | 47,387 | | | 48,964 | |
Total pledged investment securities | | $ | 100,764 | | | $ | 104,399 | |
Table 3.5 details the gross unrealized losses and fair values aggregated by investment category and length of time that individual available-for-sale securities have been in a continuous unrealized loss position at September 30, 2024 and December 31, 2023.
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Table 3.5: Securities Available-for-Sale in Continuous Unrealized Loss Positions |
(in thousands) | | Less than 12 months | | 12 months or more | | Total securities in a loss position |
| Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss | | Fair Value | | Unrealized Loss |
September 30, 2024 | | | | | | | | | | | | |
U.S. government agency securities | | $ | 865 | | | $ | (3) | | | $ | 4,796 | | | $ | (79) | | | $ | 5,661 | | | $ | (82) | |
Mortgage-backed securities | | — | | | — | | | 53,376 | | | (9,327) | | | 53,376 | | | (9,327) | |
Obligations of states and political subdivisions | | — | | | — | | | 36,966 | | | (4,421) | | | 36,966 | | | (4,421) | |
Collateralized mortgage obligations | | — | | | — | | | 301 | | | (20) | | | 301 | | | (20) | |
Corporate bonds | | — | | | — | | | 1,866 | | | (134) | | | 1,866 | | | (134) | |
Total temporarily impaired securities | | $ | 865 | | | $ | (3) | | | $ | 97,305 | | | $ | (13,981) | | | $ | 98,170 | | | $ | (13,984) | |
| | | | | | | | | | | | |
December 31, 2023 | | | | | | | | | | | | |
U.S. government agency securities | | $ | 1,130 | | | $ | (14) | | | $ | 7,081 | | | $ | (135) | | | $ | 8,211 | | | $ | (149) | |
Mortgage-backed securities | | — | | | — | | | 55,609 | | | (11,619) | | | 55,609 | | | (11,619) | |
Obligations of states and political subdivisions | | — | | | — | | | 36,930 | | | (4,841) | | | 36,930 | | | (4,841) | |
Collateralized mortgage obligations | | — | | | — | | | 332 | | | (35) | | | 332 | | | (35) | |
Corporate bonds | | — | | | — | | | 1,778 | | | (222) | | | 1,778 | | | (222) | |
Total temporarily impaired securities | | $ | 1,130 | | | $ | (14) | | | $ | 101,730 | | | $ | (16,852) | | | $ | 102,860 | | | $ | (16,866) | |
There were 145 and 149 available-for-sale securities in unrealized loss positions at September 30, 2024 and December 31, 2023, respectively. As of September 30, 2024, the investment portfolio included 143 investment securities that had been in a continuous loss position for twelve months or more and two investment securities that had been in a loss position for less than twelve months.
There was one held-to-maturity security in a continuous unrealized loss position at September 30, 2024 and December 31, 2023, which had been in a continuous loss position for more than twelve months.
Obligations issued or guaranteed by government agencies such as the GNMA and the SBA or GSEs under conservatorship such as the FNMA and the FHLMC, are guaranteed or sponsored by agencies of the U.S. government and have strong credit profiles. The Company therefore expects to receive all contractual interest payments on time and believes the risk of credit losses on these securities is remote.
The Company’s investment in obligations of states and political subdivisions is deemed credit worthy after management’s comprehensive analysis of the issuers’ latest financial information, credit ratings by major credit agencies, and/or credit enhancements.
Non-Marketable Securities Included in Other Assets
FHLB capital stock: As a member of the FHLB, the Company is required to maintain a minimum investment in FHLB capital stock determined by the board of directors of the FHLB. The minimum investment requirements can increase in the event the Company increases its total asset size or borrowings with the FHLB. Shares cannot be purchased or sold except between the FHLB and its members at the $100 per share par value. The Company held $15.0 million of FHLB stock at September 30, 2024 and December 31, 2023. The carrying amounts of these investments are reasonable estimates of fair value because the securities are restricted to member banks and do not have a readily determinable market value. Based on management’s analysis of the FHLB’s financial condition and certain qualitative factors, management determined that the FHLB stock was not impaired at September 30, 2024 or December 31, 2023.
Note 4: Loans and Allowance for Credit Losses
The Company’s loan portfolio is its largest class of earning assets and typically provides higher yields than other types of earning assets. Associated with the higher yields is an inherent amount of credit risk which the Company attempts to mitigate through strong underwriting practices. Table 4.1 presents the balance of each major product type within the Company’s portfolio as of the dates indicated.
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Table 4.1: Loans Outstanding |
(in thousands) | | September 30, 2024 | | December 31, 2023 |
Real estate: | | | | |
Commercial | | $ | 2,812,600 | | | $ | 2,685,419 | |
Commercial land and development | | 4,709 | | | 15,551 | |
Commercial construction | | 92,841 | | | 62,863 | |
Residential construction | | 3,452 | | | 15,456 | |
Residential | | 33,415 | | | 25,893 | |
Farmland | | 47,907 | | | 51,669 | |
Commercial: | | | | |
Secured | | 171,855 | | | 165,109 | |
Unsecured | | 25,011 | | | 23,850 | |
Consumer and other | | 270,760 | | | 38,166 | |
Subtotal | | 3,462,550 | | | 3,083,976 | |
Net deferred loan fees | | (1,985) | | | (2,257) | |
Loans held for investment | | 3,460,565 | | | 3,081,719 | |
Allowance for credit losses | | (37,583) | | | (34,431) | |
Loans held for investment, net of allowance for credit losses | | $ | 3,422,982 | | | $ | 3,047,288 | |
Underwriting
Commercial loans: Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay its obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Real estate loans: Real estate loans are subject to underwriting standards and processes similar to those for commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected than other loans by conditions in the real estate market or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography, and risk grade criteria.
Construction loans: With respect to construction loans that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans may be underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity
analysis of absorption and lease rates, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the completed project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the ultimate success of the project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property, or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored using on-site inspections and are generally considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions, and the availability of long-term financing.
Residential real estate loans: Residential real estate loans are underwritten based upon the borrower’s income, credit history, and collateral. To monitor and manage residential loan risk, policies and procedures are developed and modified, as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.
Farmland loans: Farmland loans are generally made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Farmland loans are secured by real property and are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions, and changes in business cycles, as well as adverse weather conditions.
Consumer loans: The Company purchased consumer loans underwritten utilizing credit scoring analysis to supplement the underwriting process. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, collection remedies, the number of such loans a borrower can have at one time, and documentation requirements.
Credit Quality Indicators
The Company has established a loan risk rating system to measure and monitor the quality of the loan portfolio. All loans are assigned a risk rating from the inception of the loan until the loan is paid off. The primary loan grades are as follows:
Loans rated pass: These are loans to borrowers with satisfactory financial support, repayment capacity, and credit strength. Borrowers in this category demonstrate fundamentally sound financial positions, repayment capacity, credit history, and management expertise. Loans in this category must have an identifiable and stable source of repayment and meet the Company’s policy regarding debt service coverage ratios. These borrowers are capable of sustaining normal economic, market, or operational setbacks without significant financial impacts and their financial ratios and trends are acceptable. Negative external industry factors are generally not present. The loan may be secured, unsecured, or supported by non-real estate collateral for which the value is more difficult to determine and/or marketability is more uncertain.
Loans rated watch: These are loans which have deficient loan quality and potentially significant issues, but losses do not appear to be imminent, and the issues may be temporary in nature. The significant issues are typically: (i) a history of losses or events that threaten the borrower’s viability; (ii) a property with significant depreciation and/or marketability concerns; or (iii) poor or deteriorating credit, occasional late payments, and/or limited reserves but the loan is generally kept current. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date.
Loans rated substandard: These are loans which are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged (if any). Loans so classified exhibit a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans are characterized by the distinct possibility that the Company may sustain some loss if the deficiencies are not corrected.
Loans rated doubtful: These are loans for which the collection or liquidation of the entire debt is highly questionable or improbable. Typically, the possibility of loss is extremely high. The losses on these loans are deferred until all pending factors have been addressed.
Table 4.2 presents the amortized cost basis of the Company’s loans by origination year, where origination is defined as the later of origination or renewal date, and credit quality indicator as of the periods indicated.
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Table 4.2: Loans by Risk Category and Vintage |
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| | Amortized Cost Basis by Origination Year as of September 30, 2024 | | | | | | |
(in thousands) | | 2024 | | 2023 | | 2022 | | 2021 | | 2020 | | Prior | | Revolving Loans | | Revolving Converted to Term | | Total |
Real estate: | | | | | | | | | | | | | | | | | | |
Commercial | | | | | | | | | | | | | | | | | | |
Pass | | $ | 323,066 | | | $ | 322,516 | | | $ | 909,581 | | | $ | 638,479 | | | $ | 212,289 | | | $ | 323,331 | | | $ | 3,141 | | | $ | — | | | $ | 2,732,403 | |
Watch | | 643 | | | — | | | 36,825 | | | 25,597 | | | 10,967 | | | 338 | | | 1,392 | | | — | | | 75,762 | |
Substandard | | — | | | — | | | — | | | — | | | — | | | 1,786 | | | — | | | — | | | 1,786 | |
| | | | | | | | | | | | | | | | | | |
Total | | 323,709 | | | 322,516 |