SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 2020
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-38317
Luther Burbank Corporation
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization)
(I.R.S. employer identification number)
520 Third St, Fourth Floor, Santa Rosa, California
(Address of principal executive offices)
Registrant's telephone number, including area code: (844) 446-8201
|Securities Registered Pursuant to Section 12(b) of the Act|
|Title of Each Class||Trading Symbol||Name of Each Exchange on Which Registered|
|Common stock, no par value||LBC||The Nasdaq Stock Market LLC|
Securities Registered Pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x
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 twelve 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 checkmark 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 checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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|
|Smaller Reporting Company||☒|
|Emerging Growth Company||☒|
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. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the
effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act): Yes ☐ No x
As of June 30, 2020, the last business day of the Registrant’s most recently completed second fiscal quarter, the aggregate market value of its common stock held by non-affiliates was approximately $114.8 million based on the closing price per share of common stock of $10.00 on June 30, 2020.
As of March 1, 2021, there were 52,229,138 shares of the registrant’s common stock, no par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be distributed on behalf of the Board of Directors of Registrant in connection with the Annual Meeting of Shareholders to be held on April 27, 2021 and any adjournment thereof, are incorporated by reference in Part III.
Table of Contents
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
All references to ‘‘we,’’ ‘‘our,’’ ‘‘us,’’ ‘‘Luther Burbank Corporation’’ or ‘‘the Company’’ refers to Luther Burbank Corporation, a California corporation, and our consolidated subsidiaries, including Luther Burbank Savings, a California banking corporation, unless the context indicates that we refer only to the parent company, Luther Burbank Corporation. ‘‘Bank’’ or ‘‘LBS’’ refers to Luther Burbank Savings, our banking subsidiary.
This Annual Report on Form 10-K contains a number of forward-looking statements. These forward-looking statements reflect our current views with respect to, among other things, future events and our results of operations, financial condition and financial performance. These statements may be identified by use of words such as "anticipate," "believe," “continue,” "could," "estimate," "expect," “impact,” "intend," "seek," "may," "outlook," "plan," "potential," "predict," "project," "should," "will," "would" and similar terms and phrases, including references to assumptions. Forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict and are often beyond the Company's control. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.
There are numerous, important factors that could cause our actual results to differ materially from those indicated in forward-looking statements, including, but not limited to, the following:
•the COVID-19 pandemic and the impact of actions to mitigate the COVID-19 pandemic;
•business and economic conditions generally and in the financial services industry, nationally and within our current and future geographic markets;
•economic, market, operational, liquidity, credit and interest rate risks associated with our business;
•the occurrence of significant natural or man-made disasters, including fires, earthquakes and terrorist acts, as well as public health issues and other adverse external events that could harm our business;
•our management of risks inherent in our real estate loan portfolio, and the risk of a prolonged downturn in the real estate market, which could impair the value of our collateral and our ability to sell collateral upon any foreclosure;
•our ability to achieve organic loan and deposit growth and the composition of such growth;
•the fiscal position of the U.S. and the soundness of other financial institutions;
•changes in consumer spending and savings habits;
•the laws and regulations applicable to our business, and the impact of recent and future legislative and regulatory changes;
•changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or our subsidiary bank in particular, more restrictive regulatory capital requirements, increased costs, including deposit insurance premiums, regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products;
•increased competition in the financial services industry;
•changes in the level of our nonperforming assets and charge-offs;
•our involvement from time to time in legal proceedings and examinations and remedial actions by regulators;
•the composition of our management team and our ability to attract and retain key personnel;
•material weaknesses in our internal control over financial reporting;
•systems failures or interruptions involving our information technology and telecommunications systems;
•potential exposure to fraud, negligence, computer theft and cyber-crime;
•failure to adequately manage the transition from LIBOR as a reference rate; and
•the effect of changes in accounting policies and practices or accounting standards, as may be adopted from time-to-time by bank regulatory agencies, the U.S. Securities and Exchange Commission ("SEC"), the Public Company Accounting Oversight Board, the Financial Accounting Standards Board ("FASB") or other accounting standards setters, including ASU 2016-13 (Topic 326), “Measurement of Credit Losses on Financial Instruments,” commonly referenced as the
Current Expected Credit Loss (“CECL”) model, which will change how we estimate credit losses and may increase the required level of our allowance for credit losses after adoption on January 1, 2023.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Annual Report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Item 1. Business
Luther Burbank Corporation is a bank holding company incorporated on May 14, 1991 under the laws of the state of California and is headquartered in Santa Rosa, California. The Company operates primarily through its wholly-owned subsidiary, Luther Burbank Savings, a California banking corporation originally chartered in 1983 in Santa Rosa, California. The Bank conducts its business from its headquarters in Gardena, CA.
The Company also owns Burbank Financial Inc., a real estate investment company, and Luther Burbank Statutory Trusts I and II, entities created to issue trust preferred securities.
The Company's principal business is attracting deposits from the general public and investing those funds in a variety of loans, including permanent mortgage loans and construction loans secured by residential, multifamily, and commercial real estate. The Company specializes in real estate secured lending in metropolitan areas along the West Coast and has developed expertise in multifamily residential, jumbo nonconforming single family residential and commercial real estate lending.
Implications of Being an Emerging Growth Company
We qualify as an ‘‘emerging growth company’’ under the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"). An emerging growth company may take advantage of specified reduced reporting requirements and is relieved of other significant requirements that are otherwise generally applicable to other public companies. Among other factors, as an emerging growth company:
•we may present less than five years of selected financial data;
•we are exempt from the requirement to provide an opinion from our auditors on the design and operating effectiveness of our internal control over financial reporting pursuant to the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act;
•we may choose not to comply with any new requirements adopted by the Public Company Accounting Oversight Board ("PCAOB");
•we are permitted to provide less extensive disclosure regarding our executive compensation arrangements pursuant to the rules applicable to smaller reporting companies, which means we do not have to include a compensation discussion and analysis and other disclosure regarding our executive compensation in this Annual Report; and
•we are not required to hold nonbinding advisory votes on executive compensation or golden parachute arrangements.
We can elect to opt out of the extended transition period for adopting any new or revised accounting standards. We have elected not to opt out of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we may adopt the standard for the private company.
We may take advantage of these provisions for up to five years from the date of our IPO unless we earlier cease to qualify as an emerging growth company. We will cease to qualify as an emerging growth company if we have more than $1.07 billion in annual gross revenues, as that amount may be periodically adjusted by the Securities and Exchange Commission ("SEC"), we become a ‘‘large accelerated filer,’’ including having more than $700.0 million in market value of our common stock held by non-affiliates, or we issue more than $1.0 billion of non-convertible debt in a three-year period.
We expect to take advantage of the reduced reporting and other requirements of the JOBS Act with respect to the periodic reports we will file with the SEC and proxy statements that we use to solicit proxies from our shareholders.
We intend to continue executing our strategic plan by focusing on the following key objectives:
•Continued organic lending growth in our existing markets. Our primary focus is to grow our client base within our strategic markets and to expand the penetration of our existing multifamily, single family and
commercial real estate lending activities within these markets in the western United States, which have historically had strong job growth, strong economic growth and limited affordable housing. These markets include all major metropolitan markets between Seattle and San Diego and we periodically evaluate opportunities to expand into additional markets in the western United States with similar characteristics. The high cost of living and high barriers to entry make these markets attractive for investments in affordable rental housing for low- and middle-income tenants. Robust job markets, strong single family residential demand, high average housing costs, and concentrations of professional, highly skilled and high income workers, entrepreneurs and other high net worth individuals make our markets ideal for our portfolio single family residential lending activities.
We believe we have a competitive advantage over larger national financial institutions, which lack our level of personalized service, and over smaller community banks, which lack our product and market expertise. We intend to capture additional market share by deepening our relationships with current customers and supporting our bankers in their pursuit of new customers in our target markets. We will also consider the opportunistic lift-out of key personnel or teams from other financial institutions. We believe that our stable, income producing property focus and our existing customer profile lends itself to expanded lending in our existing markets, as well as potential new markets.
•Deepen client relationships and grow our deposit base. We provide a high level of customer service to our depositors. Our historical focus for our deposit production activities was exclusively on individual savings deposits from high net worth, primarily self-employed individuals, entrepreneurs and professionals, and we did not emphasize transactional accounts. This strategy has produced a stable customer base. We have expanded our focus in recent years, and invested in personnel, business and compliance processes and technology that enable us to acquire, and efficiently and effectively serve, a wider array of consumer transactional accounts and business deposit accounts while continuing to provide the level of customer service for which we are known to our consumer depositors. We have also increased outreach in high-density, small to medium sized business markets where the Bank already operates. We also provide comprehensive online and mobile banking products to our business and consumer depositors to complement our branch network.
We believe that our current customer base contains additional untapped cross-selling opportunities. We plan to continue to grow our non-brokered, consumer and business deposits by:
•cross-selling business deposit relationships to our existing consumer customers who are business operators;
•cross-selling business and consumer accounts to our multifamily and single family loan borrowers;
•obtaining new individual and business customers, including specialty deposit customers, such as fiduciary service providers,1031 exchange companies, unions, homeowners associations, nonprofits and California-licensed cannabis businesses;
•increasing our digital market presence including the use of social media; and
•continuing to evaluate new branches, via de novo activity and/or acquisition, in key markets in the western United States.
We will also continue to cross-sell existing customers, and solicit new ones, for additional lending opportunities in our markets, and to develop niche verticals, where our credit underwriting expertise and efficient operations can yield an attractive risk-adjusted return. Our cross-selling efforts to existing customers will be strategically targeted, based on our in depth analyses of our customers’ overall financial profile, cash flows, financial resources and banking requirements.
•Disciplined credit quality and robust risk management. We are committed to being a high performing organization, and we intend to operate in a disciplined manner. Risk management is a core competency of our business, demonstrated by the strong credit performance of our portfolio. We have comprehensive policies and procedures for credit underwriting, monitoring our loan portfolio and internal risk management including managing our interest rate risk, compliance risk, reputation risk, legal risk and other risks inherent in our operations. The sound credit practices followed by our bankers allow credit decisions to be made efficiently and consistently. We attribute our success to a strong credit culture, the continuous evaluation of risk and return and the strict separation between business development and credit decision making,
coupled with a robust risk management framework. Our focus on credit and risk management has enabled us to originate large volumes of loans successfully while maintaining strong asset quality.
•Disciplined cost management. We intend to continue to foster a culture of efficiency through hands-on management, prudent expense management, and a small number of large deposit balance branches. With a continuing emphasis on process improvements, we believe that we can support growth in assets, customers and our geographic footprint without significant additional investment in our infrastructure or significant expansion of our personnel. We believe that our existing network of branches and loan production offices, as well as non-branch and online customer and deposit development activities, have significant potential to continue to grow loan and deposit balances. We will continue to be highly selective as we explore opportunities for establishing additional strategically located branches in markets that present significant opportunity for multifamily and commercial real estate lending, single family residential lending, and high net worth consumer and business banking relationships.
Our operations are concentrated in demographically desirable major metropolitan areas on the West Coast located in the states of California, Washington and Oregon. We have ten full service branches in California located in Sonoma, Marin, Santa Clara, and Los Angeles Counties and one full service branch in Washington located in King County. We also operate six loan production offices located throughout California, as well as a loan production office in Clackamas County, Oregon. We are most active in the following metropolitan areas: Santa Rosa (Sonoma County), Los Angeles, San Francisco, San Jose, San Diego, and Seattle. We are seeking to more deeply penetrate these core markets, and other major metropolitan markets that share key demographic characteristics with our core markets.
We operate in a highly competitive industry and in highly competitive markets throughout the West Coast. While our commercial real estate and jumbo single family residential focuses require significant expertise to perform efficiently, competition in commercial real estate lending is keen from large banking institutions with national operations and mid-sized regional banking institutions, while in the single family lending market, we face competition from a wide array of institutions. We compete with other community banks, savings and loan associations, credit unions, mortgage companies, insurance companies, finance companies, as well as other kinds of financial institutions and enterprises, such as securities firms, insurance companies, private lenders and nontraditional competitors such as fintech companies and internet-based lenders, depositories and payment systems. The primary factors driving competition for deposits are customer service, interest rates, fees charged, branch locations and hours, online and mobile banking functionality, the range of products offered and the reputation/public perception of an institution. The primary factors driving competition for our lending products are customer service, range of products offered, price, reputation, and quality of execution. We believe the Bank is a strong competitor in our markets; however, other competitors have advantages over us. Among the advantages that many of these large institutions have over the Bank are their abilities to finance extensive advertising campaigns, maintain extensive branch networks, generate fee and other noninterest income, make larger technology investments and offer services that we do not offer. The higher capitalization of the larger institutions permits them to provide higher lending limits than we can, although our current lending limit is able to accommodate the credit needs of most of our borrowers. Some of these competitors have other advantages, such as tax exemption in the case of credit unions, and to some extent, lesser regulation in the case of mortgage companies and finance companies.
Our primary multifamily competitor is JPMorgan Chase & Co. Additional competitors include, but are not limited to, Pacific Premier Bancorp, Inc., First Foundation, Inc., Homestreet Bank and Umpqua Bank. Our primary single family lending competitors in our markets are MUFG Union Bank, N.A., Fremont Bank, WaFd Bank, various non-bank mortgage lenders, and large national banks. Our primary deposit competitors are local regional banks, community banks, numerous credit unions and large national banks.
The primary components of our loan portfolio are multifamily and commercial real estate loans and single family residential loans, primarily jumbo loans which do not meet the requirements for conforming loans.
•Multifamily and Commercial Real Estate Lending.
Our commercial real estate loans consist primarily of first mortgage loans made for the purpose of purchase, refinance or build-out of tenant improvements on investor owned multifamily residential (five or more units) properties. We also provide loans for the purchase, refinance or improvement of office, retail and light industrial properties.
Our underwriting guidelines for multifamily and other commercial real estate loans require a thorough analysis of the financial performance, cash flows, loan to value and debt service coverage ratios, as well as the physical characteristics of the property being financed and which will stand as collateral for the loan, as well as the financial condition and global cash flows of the borrower and any guarantor or other secondary source of repayment. We also closely review the experience of the borrower and its principals in the ownership, successful management and financing of multifamily residential rental properties or other rental commercial real estate, as well as their reputation for quality business practices and financial responsibility.
The location of the property is a primary factor in the Bank’s multifamily lending. We focus on markets with a high barrier to entry for new development, where there is a limited supply of new housing and where there is a high variance between the cost to rent and the cost to own. Our core lending areas are currently defined as:
•Alameda, Contra Costa, Los Angeles, Marin, Napa, Orange, San Diego, San Francisco, San Mateo, Santa Barbara, Santa Clara, Sonoma and Ventura counties in California;
•Clark, King, Kitsap, Pierce and Snohomish counties in Washington; and
•Clackamas, Multnomah, and Washington counties in Oregon.
Our extended core lending areas are currently defined as:
•El Dorado, Monterey, Placer, Riverside, Sacramento, San Bernardino, San Luis Obispo, Santa Cruz, Solano and Yolo counties in California;
•Spokane and Thurston counties in Washington; and
•Lane and Marion counties in Oregon.
We may re-evaluate and revise the definitions of our core and extended core areas from time to time. Non-core markets include all markets in California, Oregon or Washington not categorized as core or extended core.
We make multifamily loans on a recourse or nonrecourse basis. We may require borrowers to provide personal guarantees in a variety of circumstances, including where a borrower lacks sufficient property ownership and management experience, or where specific loan characteristics do not meet our stringent underwriting criteria, including but not limited to loans with higher loan to value ratios or lower debt service coverage ratios. Loans on other commercial real estate are generally made on a comparable basis.
Our multifamily loans typically have a 30-year term, while our nonresidential commercial property loans have a 30-year amortization period, and are typically due in ten years. For commercial real estate, we offer adjustable rate loans based on Treasury indices, with an adjustable rate, 5-year hybrid product being our most common multifamily loan product type. Historically, our multifamily adjustable rate loans were originated primarily using the LIBOR index; however, use of this index was discontinued during 2019. We seek to have interest rates on all of our commercial loans adjust or reprice no later than ten years after origination, and quarterly or semi-annually thereafter, but our ability to obtain this term is subject to the effects of market competition, customer preferences and other factors beyond our control.
Our multifamily loans and other commercial real estate loans are primarily originated on a retail basis, through the marketing efforts of our bankers and loan production offices, and to a lesser extent, are originated on a wholesale basis, through a network of brokers. We intend to maintain a balance of both retail and wholesale loan originations, while tailoring our approach to the characteristics of each particular market. While our multifamily and other commercial real estate loans are generally held in portfolio, we may at times sell pools of loans as a means of managing our loan product concentrations, liquidity position, capital levels and/or interest rate risk.
•Single Family Residential Lending.
Our single family residential lending provides loans for the purchase or refinance of 1-4 family residential properties. The financed properties may be owner-occupied, or investor owned, and may be a primary residence, a second home or vacation property, or an investment property.
We currently originate substantially all of our single family residential loans through a network of wholesale brokers. We monitor and regularly review our broker relationships for regulatory compliance, integrity, competence and level of activity. The primary products offered are 3, 5, 7, and 10-year variable rate hybrid loans, as well as the Grow and Daisy loan products described below.
The markets in which we make single family residential loans have historically been the same core and extended core markets in which we make multifamily residential and commercial real estate loans. These areas have been characterized by robust job markets, strong single family residential demand, high average housing cost, and concentrations of professional, highly skilled and high income workers, entrepreneurs and other high net worth individuals. These characteristics have provided a strong market for our jumbo mortgage products. Our loans are underwritten to our financial parameters of loan to value and debt to income ratios. Our underwriting includes a thorough analysis of the borrower’s ability to repay the loan, based on reviews of information regarding the borrower’s income, cash flow and wealth. This analysis enables us to provide loans to professionals, business owners and entrepreneurs who may not have a constant, readily documentable earnings stream, but substantial assets, income and wealth. Our platform and niche lending offerings are designed to meet the needs of the high demand, low supply residential real estate market in high cost market areas, and are focused on delivering certainty of execution. Our single family residential loans are generally held in portfolio, although we reserve the right to sell any loan at any time.
•Grow and Daisy.
We also offer a portfolio 30-year fixed rate first mortgage and a forgivable second mortgage, to low- and moderate-income borrowers designed to make home ownership possible and affordable even in our high cost markets. Our ‘‘Grow’’ program is designed as a conventional, community lending mortgage, up to the conforming loan amount, that offers underwriting flexibility to low- and moderate-income borrowers and borrowers purchasing properties located in low- or moderate- income communities. Loans in this program are 30-year fixed rate mortgages made on owner-occupied single family (one and two unit) properties, including condominiums. Pricing on this product is competitive at market rate.
In conjunction with the Grow program, we also offer a down payment and closing cost assistance product, called ‘‘Daisy.’’ Under the Daisy program, eligible borrowers may take advantage of our second lien loan that provides up to two percent of the purchase price with an additional one percent for non-recurring closing costs to assist first time homebuyers when utilizing Grow, our first lien program. The loan has a term of 36 months with no payment required during the term of the Daisy loan. Daisy loans are not recorded as assets, but are instead expensed upon origination given their fully forgivable nature.
Loans under the Grow and Daisy programs help meet compelling needs in our communities, but may be associated with higher loan to value and combined loan to value ratios when compared to our standard portfolio products.
Our investment securities portfolio is primarily maintained as an on-balance sheet contingent source of liquidity. It provides additional interest income and has limited interest rate risk and credit risk. Other than certain securities purchased for Community Reinvestment Act ("CRA") purposes, we generally classify all of our investment securities as available for sale. Our investment policy authorizes investment primarily in U.S. Treasury securities, U.S. Agency mortgage and loan backed securities and certain CRA qualifying investments. For purposes of our investment policy, U.S. Agencies are the Small Business Administration ("SBA"), the National Credit Union Administration ("NCUA"), the Government National Mortgage Association ("GNMA"), the Federal Home Loan Mortgage Corporation ("Freddie Mac"), the Federal National Mortgage Association ("Fannie Mae") and the Federal Farm Credit Banks Funding Corporation. Securities issued by the SBA, NCUA and GNMA are backed by the full faith and credit of the federal government.
We offer a wide array of deposit products for individuals and businesses, including interest and noninterest-bearing transaction accounts, certificates of deposit ("CD") and money market accounts. We provide a high level of customer service to our depositors. As a means of supplementing our strategically located branch network, we offer our consumer customers unlimited free access to ATM machines worldwide. Our strategy has produced a stable customer and depositor base. We have invested in personnel, business and compliance processes and technology that enable us to acquire, and efficiently and effectively serve, a wide array of business deposit accounts, while continuing to provide the level of customer service for which we are known to our depositors.
Our deposits are currently acquired primarily through our branch network on a retail basis from high net worth individuals, professionals and their businesses, who value our financial strength, stability, high level of service and competitive interest rates. We have expanded our focus to leverage our relationships and serve business and individuals with a broader array of deposit, card and cash management products. We intend to increase our digital marketing presence to attract deposits within a wider geographic band surrounding our existing branch locations.
We currently offer a comprehensive range of business deposit products and services to assist with the banking needs of our business customers, from a basic reserve account (savings and CD products) to integrated operating accounts with cash management capacity. Our online banking platform allows a customer to view balances, initiate payments, pay bills and set up custom alerts/statements. Online wires, ACH and remote capture are additional account features available to qualified businesses. Our debit cards allow access to cash nationwide as a result of our membership in major ATM networks. We also provide online and mobile banking products to our depositors, to complement our branch network.
We grow our deposits by cross-selling business deposit relationships to our existing consumer customers who are business owners, and consumer and business accounts to our multifamily and single family loan borrowers and by obtaining new individual and business customers, including specialty deposit customers, such as fiduciary services providers, 1031 exchange companies, unions, nonprofits and California-licensed cannabis businesses. Our cross-selling efforts to existing customers are strategically targeted, based on our in depth analyses of our customers’ overall financial situation, global cash flows, financial resources and banking requirements. We believe there is additional capacity to expand deposit and lending relationships on this basis.
We supplement customer deposits with wholesale, or brokered, deposits where necessary to fund loan demand prior to raising additional customer deposits, or where desirable from a cost or liability maturity standpoint. Our current policy limits the use of wholesale deposits in accordance with our risk appetite level as determined by our board of directors.
We supplement the funding provided by our deposit accounts with other borrowings at the Bank level from the Federal Home Loan Bank of San Francisco ("FHLB") to enable us to fund loans and to meet liquidity needs. We also maintain a line of credit at the Federal Reserve Bank of San Francisco ("FRB") Discount Window, which is generally not used but provides an additional source of funding, if necessary. The use of FHLB borrowings can vary significantly from period to period, as the ability to originate loans may outpace the ability to obtain core deposits at acceptable rates and in comparable amounts.
We believe that effective risk management is of primary importance. Risk management refers to the activities by which we identify, measure, monitor, evaluate and manage the risks we face in the course of our banking activities. These include liquidity, interest rate, credit, operational, compliance, regulatory, strategic, financial and reputational risk exposures. Our board of directors and management team have created a risk-conscious culture that is focused on quality growth, which starts with capable and experienced risk management teams and infrastructure capable of addressing the evolving risks we face, as well as the changing regulatory and compliance landscape. Our risk management approach employs comprehensive policies and processes to establish robust governance and emphasizes personal ownership and accountability for risk with all our employees. We believe a disciplined and conservative underwriting approach has been the key to our strong asset quality.
Our board of directors sets the tone at the top of our organization, adopting and overseeing the implementation of our Bank’s risk management framework, which establishes our overall risk appetite and risk management strategy. The Board of Directors approves our Risk Appetite Statement, which includes risk policies, procedures, limits, targets and reporting, structured to guide decisions regarding the appropriate balance between risk and return considerations in our business. Our board of directors receives periodic reporting on risks and control environment effectiveness and monitors risk levels in relation to the approved risk appetite. The Audit & Risk Committee of our board of directors provides oversight of all enterprise risk management. The Executive Committee of management is charged with identifying, managing and controlling key risks that threaten our ability to achieve our strategic initiatives and goals.
Credit risk is the risk that borrowers or counterparties will be unable or unwilling to repay their obligations in accordance with the underlying contractual terms and the risk that credit collateral will suffer significant deterioration in market value. We manage and control credit risk in our loan portfolio by adhering to well-defined underwriting criteria and account administration standards established by management and approved by the Board of Directors. Written credit policies document underwriting standards, approval levels, exposure limits and other limits or standards deemed necessary and prudent. Portfolio diversification at the obligor, product and geographic levels is actively managed to mitigate concentration risk. In addition, credit risk management includes an independent credit review process that assesses compliance with commercial real estate and consumer credit policies, risk rating standards and other critical credit information. In addition to implementing risk management practices that are based upon established and sound lending practices, we adhere to sound credit principles. We understand and evaluate our customers’ borrowing needs and capacity to repay, in conjunction with their character and history. The Bank’s Credit Council, which includes our President and Chief Executive Officer, our Chief Credit Officer, Chief Financial Officer and Chief Risk Officer, is responsible for ensuring that the Bank has an effective credit risk management program and credit risk rating system, adheres to our board’s Risk Appetite Statement, and maintains an adequate allowance for loan losses. Our management and board of directors place significant focus on maintaining a healthy risk profile and ensuring sustainable growth. Our risk appetite seeks to balance the risks necessary to achieve our strategic goals while ensuring that our risks are appropriately managed and remain within our defined limits.
Our management of interest rate and liquidity risk is overseen by our Asset and Liability Council, which is chaired by our Chief Financial Officer, based on a risk management infrastructure approved by our board of directors that outlines reporting and measurement requirements. In particular, this infrastructure reviews financial performance, trends, and significant variances to budget; reviews and recommends for board approval risk limits and tolerances; reviews ongoing monitoring and reporting regarding our performance with respect to these areas of risk, including compliance with board-approved risk limits and stress-testing; reviews and recommends to the Executive Committee for approval any changes to theories, mathematics, methodologies, assumptions, and data output for models used to measure these risks; ensures annual back-testing and independent validation of models at a frequency commensurate with risk level; reviews all hedging strategies and recommends changes as appropriate; reviews and recommends our contingency funding plan; recommends to the Executive Committee proposed wholesale borrowing limits to be submitted to the Board of Directors or its designated committee; recommends to the Executive Committee the proposed terms of any unanticipated long-term borrowing arrangement prior to debt issuance; develops recommended capital requirements; and reviews information and reports submitted to the Council for the purpose of identifying, investigating, and assuring remediation of any potential issues.
Internet Access to Company Documents
The Company provides access to its SEC filings through its web site at www.lutherburbanksavings.com. After accessing the web site, the filings are available upon selecting "About Us/Investor Relations/Financials/SEC Filings." Reports available include the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed with or furnished to the SEC. Further, the SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. All website addresses given in this document are for information only and are not intended to be an active link or to incorporate any website information into this document.
Luther Burbank Corporation Foundation
In 2017, we established the Luther Burbank Corporation Foundation ("Foundation") which was granted 501(c)(3) status by the Internal Revenue Service ("IRS"). The Foundation is an all-volunteer organization primarily funded by
the Company, as well as from our directors, business partners and a corporate giving program that matches employee donations. The Foundation focuses its activities in our communities on the three priority areas of (1) social and human services; (2) community development; and (3) education.
As of both December 31, 2020 and 2019, we had 277 full and part time employees, nearly all of whom are full-time. As a financial institution, approximately 28% of our employees are employed at our branch and loan production offices. The remaining portion of our employees generally work from our administrative offices throughout Northern and Southern California. Our business is highly dependent on the success of our employees, who provide value to our customers and communities through their dedication to our mission, which is to improve the financial future of our customers, employees and shareholders. Our core values are based on acting ethically and with integrity to provide superior service to our customers and each other with the goal of achieving our mantra that “you’re worth more here”. To further promote our core values, we acknowledge and reward employees throughout the year that exemplify these values.
We seek to hire well-qualified employees who are also a good fit for our value system. In 2020, 47% of our new hires were made as a result of an employee referral. During the years ended December 31, 2020 and 2019, our employee voluntary turnover ratios were 13% and 10%, respectively. As of December 31, 2020, 42% of our employees were employed with us for five years or longer. Our selection and promotion processes are without bias and include the active recruitment of minorities and women. As of December 31, 2020 and 2019, women represented 67% and 69%, respectively, of our workforce, and 56% and 63%, respectively, of our executive management team. As of December 31, 2020, the population of our workforce, based on employee self-reported information or Human Resources’ observation, was as follows:
(a) Minorities are defined as all U.S. Equal Employment Opportunity Commission categories other than white.
We strive to provide a competitive compensation and benefits program to help meet the needs of our employees. In addition to salaries, these programs include incentive compensation plans, stock awards, a 401(k) Plan with an employer matching contribution, healthcare and insurance benefits, health savings and flexible spending accounts, paid time off, family leave and an employee assistance program.
The safety, health and wellness of our employees is a top priority. The COVID-19 pandemic presented a unique challenge with regard to maintaining employee safety while performing our daily operations. Through teamwork and the adaptability of our management and staff, we were able to safely transition approximately 75% of our non-branch employees to remote working arrangements. In addition, because financial institutions have been designated as an essential component of our nation’s critical infrastructure, all of our branches have remained open during the pandemic. To limit our branch employees' exposure to risks related to COVID-19, we have temporarily modified our branch hours, expanded our phone support systems and enhanced branch safety protocols. In recognition of the demands on families caused by "stay-at-home" orders and other precautionary measures, our employees are also being permitted to utilize a flexible work schedule to maintain our Company's productivity while fulfilling personal responsibilities. We have also provided other benefits such as wellness allowances for customer facing employees, the cash-out of a limited amount of accrued and unused vacation, as well as paid time off and counseling services for employees requiring additional assistance. On an ongoing basis, we further promote the
health and wellness of our employees by strongly encouraging work-life balance, keeping the employee portion of health care premiums to a minimum and sponsoring various educational and wellness programs.
Item 1A. Risk Factors
In the course of our business operations, we are exposed to numerous risks, some of which are inherent in the financial services industry and others of which are more specific to our own business. The discussion below addresses the material factors, of which we are currently aware, that could affect our business, results of operations and financial condition. The risk factors below should not be considered a complete list of potential risks that we may face. Any risk factor described in this Annual Report on Form 10-K or in any of our SEC filings could by itself, or together with other factors, materially adversely affect our liquidity, competitive position, reputation, results of operations, capital position or financial condition, including by materially increasing our expenses or decreasing our revenues, which could result in material losses.
Some statements in these risk factors constitute forward-looking statements that involve risks and uncertainties. Please refer to the section entitled "Cautionary Note Regarding Forward-Looking Statements."
Economic and Market Conditions Risk
Our business and operations may be materially adversely affected by weak economic conditions.
Our business and operations, which primarily consist of banking activities, including lending money to customers in the form of real estate secured loans and borrowing money from customers in the form of deposits, are sensitive to general business and economic conditions in the U.S. generally, and on the West Coast in particular, which may differ from economic conditions in the U.S. as a whole. If economic conditions in the U.S. or any of our markets weaken, our growth and profitability from our operations could be constrained. In addition, foreign economic and political conditions could affect the stability of global financial markets, which could hinder economic growth. Our business is also significantly affected by monetary and related policies of the U.S. federal government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse economic conditions caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, pandemics, unemployment, changes in securities markets, declines in the housing market, a tightening credit environment or other factors, and government policy responses to such conditions, could have a material adverse effect on our business, financial condition and results of operations.
Our business and operations may be materially adversely affected by the COVID-19 pandemic and governmental authorities’ responses to the COVID-19 pandemic.
In December 2019, the COVID-19 outbreak was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. Since March 13, 2020, the U.S. has been operating under a state of emergency declared in response to the spread of COVID-19. Many local and state governments, including the State of California, have instituted emergency restrictions that have substantially limited the operation of non-essential businesses and the activities of individuals. We are sensitive to general business and economic conditions in the U.S. generally, and on the West Coast in particular. The duration and impacts of the pandemic and governmental authorities’ responses to it are not yet known or knowable. Circumstances related to the COVID-19 pandemic and related events continue to change quickly. The spread of COVID-19, and government responses to it, have resulted in increased volatility in financial markets, large increases in unemployment and the closure, at times, of non-essential businesses in our markets. The extent of COVID-19’s impact on us is unpredictable and depends on a number of factors outside of our control, such as the scope and duration of the pandemic, the nature and scope of any resulting economic downturn, the emergence of COVID-19 variants, customer response, and actions that governmental authorities may take in response to the pandemic.
Given the ongoing and dynamic nature of the circumstances, it is not possible to predict the ultimate impact of the pandemic on our stock price, business prospects, financial condition or results of operations. COVID-19 could cause a decline in the value of mortgaged properties that serve as our collateral and increase the risk of delinquencies, defaults, foreclosures and losses on our loans, negatively impact regional economic conditions, result in a decline in loan demand and loan originations, result in drawdowns of deposits by customers impacted by COVID-19, result in branch or office closures and business interruptions, and negatively impact the implementation
of our business strategy. COVID-19, and governmental authorities’ responses to it, may also result in prolonged adverse economic conditions which could constrain our growth and profitability from our operations, and could have a material adverse effect on our business, financial condition and results of operations.
Many of our financial instruments are priced based on variable interest rates tied to the London Interbank Offered Rate ("LIBOR"). We are subject to risks that LIBOR may no longer be available as a result of the United Kingdom’s Financial Conduct Authority ceasing to require the submission of LIBOR quotes after the year ending 2021.
The expected discontinuation of LIBOR quotes creates substantial risks to the banking industry, including us. Generally all of our loans provide for an alternative index to be selected by us as a substitute index from among the most widely followed financial indexes should LIBOR become unavailable. However, uncertainty as to the establishment of, as well as the future performance of, an alternative index could adversely affect our asset liability management and could lead to more asset and liability mismatches and interest rate risk, or may have other consequences which cannot be predicted. The cessation of LIBOR could also cause confusion that could disrupt the capital and credit markets as a result. Additionally, there may be borrower resistance to the establishment of an alternative index, which could result in potential litigation or defaults.
The Federal Reserve has sponsored the Alternative Reference Rates Committee ("ARRC"), which serves as a forum to coordinate and track planning as market participants currently using LIBOR consider (a) transitioning to alternative reference rates where it is deemed appropriate and (b) addressing risks in legacy contracts language given the possibility that LIBOR might stop. On April 3, 2018, the Federal Reserve began publishing three new reference rates, including the Secured Overnight Financing Rate ("SOFR"). ARRC has recommended SOFR as the alternative to LIBOR, and published fallback interest rate consultations for public comment and a Paced Transition Plan to SOFR use. The viability of SOFR as an alternative index is unclear. The Financial Stability Board has taken an interest in LIBOR and possible replacement indices as a matter of risk management. The International Organization of Securities Commissions ("IOSCO"), has been active in this area and is expected to call on market participants to have backup options if a reference rate, such as LIBOR, ceases publication. The International Swap Dealers Association has published guidance on interest rate bench marks and alternatives in July and August 2018. In November 2020, the Intercontinental Exchange ("ICE") Benchmark Administration ("IBA") announced that it was proposing to continue to publish the most common LIBOR tenors through June 2023, or a one and a half year extension to what was previously anticipated. In response, an interagency joint statement was issued by federal regulators that encouraged banks to cease entering new contracts using LIBOR as soon as practicable and further clarified that the use of LIBOR in agreements executed after December 31, 2021 would create a safety and soundness issue.
As of December 31, 2020, we had $1.2 billion of loans, $397.0 million of investments, $61.9 million of junior subordinated deferrable interest debentures and $15.9 million of other assets that were indexed to LIBOR and that have stated maturity dates after December 31, 2021. We are currently evaluating replacement indices for our loan portfolio and anticipate substituting these instruments with SOFR or another comparable index. Replacement indices for all other assets and liabilities noted herein will be determined by third parties and, to date, such replacement indices have not been announced. It cannot be predicted whether SOFR or another index or indices will become a market standard that replaces LIBOR, and if so, the effects on our customers, or our future results of operations or financial condition.
Interest Rate Risk
We are subject to interest rate risk, which could adversely affect our profitability.
Our profitability, like that of most financial institutions, depends to a large extent on our net interest income, which is the difference between our interest income on interest-earning assets, such as loans and investment securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowings.
Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System, or the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes could affect our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our assets. If the interest rates paid on deposits and
other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected or prolonged change in market interest rates could have a material adverse impact on our business, financial condition and results of operations.
Our interest sensitivity profile was liability sensitive as of December 31, 2020. When short-term interest rates rise, the rate of interest we pay on our interest-bearing liabilities, such as deposits, may rise more quickly than the rate of interest that we receive on our interest-earning assets, such as loans, which may cause our net interest income to decrease. Additionally, a shrinking yield premium between short-term and long-term market interest rates, a pattern typically indicative of investors' waning expectations of future growth and inflation, commonly referred to as a flattening of the yield curve, as well as an inverted yield curve, where long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality, typically reduce our profit margin since we borrow at shorter terms than the terms at which we lend and invest.
In addition, an increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations. These circumstances could not only result in increased loan defaults, foreclosures and charge-offs, but also reduce collateral values and necessitate further increases to the allowance for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
We are subject to credit risk, which could adversely impact our profitability.
Our business depends on our ability to successfully measure and manage credit risk. As a lender, we are exposed to the risk that the principal of, or interest on, a loan will not be paid timely or at all or that the value of any collateral supporting a loan will be insufficient to cover our outstanding exposure. In addition, we are exposed to risks with respect to the period of time over which the loan may be repaid, risks relating to loan underwriting, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual loans and borrowers. The creditworthiness of a borrower is affected by many factors including local market conditions and general economic conditions. If the overall economic climate experiences material disruption, our borrowers may experience difficulties in repaying their loans, the collateral we hold may decrease in value or become illiquid, and the level of nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for loan losses. Additional factors related to the credit quality of multifamily residential and other commercial real estate (“CRE”) loans include the quality of management of the business and tenant vacancy rates.
Our risk management practices, such as monitoring the concentration of our loans within specific markets and product types and our credit approval, review and administrative practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of the loan portfolio. Many of our loans are made to small businesses that are less able to withstand competitive, economic and financial pressures than larger borrowers. Consequently, we may have significant exposure if any of these borrowers become unable to pay their loan obligations as a result of economic or market conditions, or personal circumstances, such as divorce, unemployment or death. A failure to effectively measure and limit the credit risk associated with our loan portfolio may result in loan defaults, foreclosures and additional charge-offs, and may necessitate that we significantly increase our allowance for loan losses, each of which could adversely affect our net income. As a result, our inability to successfully manage credit risk could have a material adverse effect on our business, financial condition and results of operations.
Our multifamily residential and commercial real estate loan portfolios may carry significant credit risk.
Our loan portfolio consists primarily of multifamily residential and, to a lesser extent, other CRE loans, which are primarily secured by industrial, office and retail properties. As of December 31, 2020, our multifamily residential loans totaled $4.1 billion, or 67.8% of our loan portfolio, and our other CRE loans totaled $202.9 million, or 3.4% of our loan portfolio. Nonperforming multifamily residential loans were $522 thousand at December 31, 2020. There were no nonperforming other CRE loans at December 31, 2020. CRE loans may carry significant credit risk because they typically involve large loan balances concentrated with a single borrower or groups of related
borrowers. The payment on these loans that are secured by income-producing properties are typically dependent on the successful operation of the related real estate property and may subject us to risks from adverse conditions in the real estate market or the general economy. Investment in these properties by our customers is influenced by prices and return on investment, as well as changes to applicable laws regarding, among other things, rent control, moratoriums on evictions for non-payment, personal and corporate tax reform, pass-through rules, immigration and fiscal and economic policy. The collateral securing these loans typically cannot be liquidated as easily as single family residential (“SFR”) real estate, which may lead to longer holding periods. If these properties become less attractive investments, demand for our loans would decrease. In addition, unexpected deterioration in the credit quality of our multifamily residential or CRE loan portfolios could require us to increase our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.
We are subject to increasing credit risk as a result of the COVID-19 pandemic, which could adversely impact our profitability.
Our business depends on our ability to successfully measure and manage credit risk. As a mortgage lender, we are exposed to the risk that the principal of, or interest on, a loan will not be paid timely or at all or that the value of any collateral supporting a loan will be insufficient to cover our outstanding exposure. In addition, we are exposed to risks with respect to the risks resulting from changes in economic and industry conditions and risks inherent in dealing with individual loans and borrowers. As the overall economic climate in the U.S. generally, and in our market areas specifically, experiences material disruption due to the COVID-19 pandemic, our borrowers may experience difficulties in repaying their loans and governmental actions may preclude our ability to initiate foreclosure proceedings in certain circumstances, and as a result, the collateral we hold may decrease in value or become illiquid, and the level of nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for loan losses. Additional factors related to the credit quality of investor-owned SFR, multifamily residential and other CRE loans include the duration of state and local moratoriums on evictions for non-payment of rent or other fees. Our inability to successfully manage the increased credit risk caused by the COVID-19 pandemic could have a material adverse effect on our business, financial condition and results of operations.
Our allowance for loan losses may be inadequate to absorb probable incurred losses inherent in the loan portfolio, which could have a material adverse effect on our business, financial condition and results of operations.
We periodically review our allowance for loan losses for adequacy considering historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accrual loans, economic conditions and other pertinent information. The determination of the appropriate level of the allowance for loan losses is inherently highly subjective and requires us to make significant estimates of and assumptions regarding current credit risk and future trends, all of which may change materially. Although we endeavor to maintain our allowance for loan losses at a level adequate to absorb any probable incurred losses inherent in the loan portfolio, these estimates of loan losses are necessarily subjective and their accuracy depends on the outcome of future events. Inaccurate management assumptions, continuing deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require us to increase our allowance for loan losses. In addition, our regulators, as an integral part of their examination process, periodically review our loan portfolio and the adequacy of our allowance for loan losses and may require adjustments based upon judgments that are different than those of management. Differences between our actual experience and assumptions and the effectiveness of our models could adversely affect our business, financial condition and results of operations.
Lack of seasoning of our loan portfolio could increase risk of credit defaults in the future.
As a result of our organic growth over the past several years, as of December 31, 2020, approximately $4.7 billion, or 78.1%, of the loans in our loan portfolio were originated since January 1, 2017, of which 11.8% were from in-house refinancings. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process referred to as "seasoning." As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Although a significant portion of our multifamily portfolio is refinancings of prior loans on the same property, a large portion of our loan portfolio is relatively new, and therefore, the current level of delinquencies and defaults may not represent the level that may prevail as the portfolio becomes more seasoned and may not serve as a reliable basis for predicting the health and nature of our
loan portfolio, including net charge-offs and the ratio of nonperforming assets in the future. Our limited experience with these loans does not provide us with a significant history pattern with which to judge future collectability or performance. However, we believe that our stringent credit underwriting process, our ongoing credit review processes, and our history of successful management of our loan portfolio, mitigate these risks. Nevertheless, if delinquencies and defaults increase, we may be required to increase our provision for loan losses, which could have a material adverse effect on our business, financial condition and results of operations.
Our SFR loan portfolio possesses increased risk due to our level of non-conforming loans.
Many of the residential mortgage loans we have originated consist of SFR loans that do not conform to Fannie Mae or Freddie Mac underwriting guidelines as a result of loan terms, loan size, or other exceptions from agency underwriting guidelines. Additionally, many of our loans do not meet the qualified mortgage (“QM”) definition established by the Consumer Financial Protection Bureau (“CFPB”), and therefore, contain additional regulatory and legal risks. In addition, the secondary market demand for non-conforming and non-QM mortgage loans is generally limited, and consequently, we may experience difficulties selling the non-conforming loans in our portfolio should we decide to do so.
We are exposed to higher credit risk due to relationship exposure with a number of large borrowers.
As of December 31, 2020, we had 19 borrowing relationships in excess of $20 million which accounted for approximately 7.6% of our loan portfolio. While we are not overly dependent on any one of these relationships and while none of these relationships have had any material credit quality issues in the past, a deterioration of any of these credit relationships could require us to increase our allowance for loan losses or result in significant losses to us, which could have a material adverse effect on our business, financial condition and results of operations.
Geographic Concentration Risk
Our business and operations are concentrated in California and Washington, and we are more sensitive than our more geographically diversified competitors to adverse changes in the local economy.
Unlike many of our larger competitors that maintain significant operations located outside our market areas, substantially all of our customers are individuals and businesses located and doing business in the states of California and Washington. As of December 31, 2020, approximately 88% of the loans in our portfolio measured by dollar amount were secured by collateral located in California and 10% of the loans in our portfolio measured by dollar amount were secured by collateral located in Washington. In addition, 62% of our real estate loans measured by dollar amount, were secured by collateral located in southern California counties. Therefore, our success will depend upon the general economic conditions in these areas, which we cannot predict with certainty. As a result, our operations and profitability may be more adversely affected by a local economic downturn than those of large, more geographically diverse competitors. A downturn in the local economy could make it more difficult for our borrowers to repay their loans and may lead to loan losses that are not offset by operations in other markets; it may also reduce the ability of depositors to make or maintain deposits with us. For these reasons, any regional or local economic downturn could have a material adverse effect on our business, financial condition and results of operations.
Our ability to conduct our business could be disrupted by natural or man-made disasters.
A significant number of our offices, and a significant portion of the real estate securing loans we make, and our borrowers' business operations in general, are located in California. California has had and will continue to have major earthquakes in areas where a significant portion of the collateral and assets of our borrowers are concentrated. California is also prone to natural and climate change related disasters, including fires, mudslides, floods and other disasters. Additionally, acts of terrorism, war, civil unrest, violence, or other man-made disasters could also cause disruptions to our business or to the economy as a whole. The occurrence of natural or man-made disasters could destroy, or cause a decline in the value of, mortgaged properties that serve as our collateral and increase the risk of delinquencies, defaults, foreclosures and losses on our loans, damage our banking facilities and offices, negatively impact regional economic conditions, result in a decline in loan demand and loan originations, result in drawdowns of deposits by customers impacted by disasters and negatively impact the implementation of our growth strategy. We have implemented a disaster recovery and business continuity plan that allows us to move critical functions to a backup data center in the event of a catastrophe. Although this program is tested periodically, we cannot guarantee its effectiveness in any disaster scenario. Regardless of the effectiveness of our disaster
recovery and business continuity plan, the occurrence of any natural or man-made disaster could have a material adverse effect on our business, financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and meet our obligations as they become due and failure to maintain sufficient liquidity could materially adversely affect our growth, business, profitability and financial condition.
Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding at a reasonable cost, in a timely manner and without adverse conditions or consequences. We require sufficient liquidity to fund asset growth, meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. Liquidity risk can increase due to a number of factors, including an over-reliance on a particular source of funding or market-wide phenomena such as market dislocation and major disasters. Factors that could detrimentally impact access to liquidity sources include, but are not limited to, a decrease in the level of our deposit activity as a result of a downturn in the markets in which our loans are concentrated, adverse regulatory actions against us, or changes in the liquidity needs of our depositors. Market conditions or other events could also negatively affect the level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Our inability to raise funds through deposits, borrowings, the sale of loans, and other sources could have a substantial negative effect on our business, and could result in the closure of the Bank. Our access to funding sources in amounts adequate to finance our activities or on acceptable terms could be impaired by factors that affect our organization specifically or the financial services industry or economy in general. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity could impair our ability to fund operations and meet our obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.
We rely on customer deposits, advances from the FHLB and brokered deposits to fund our operations. Although we have historically been able to replace maturing deposits and advances, if desired, we may not be able to replace such funds in the future if our financial condition, our CRA rating, the financial condition of the FHLB or market conditions change. FHLB borrowings and other current sources of liquidity may not be available or, if available, sufficient to provide adequate funding for operations.
We may not be able to retain or grow our core deposit base, which could adversely impact our funding costs.
Like many financial institutions, we rely on customer deposits as our primary source of funding for our lending activities, and we continue to seek customer deposits to maintain this funding base. Our future growth will largely depend on our ability to retain and grow our deposit base. As of December 31, 2020, we had $5.3 billion in deposits and a loan to deposit ratio of 115%, which is higher than the level maintained by many other banks. As of the same date, using deposit account related information such as tax identification numbers, account vesting and account size, we estimated that $1.4 billion of our deposits exceeded the insurance limits established by the Federal Deposit Insurance Corporation ("FDIC"). None of our deposits are governmental deposits secured by collateral. Although we have historically maintained a high deposit customer retention rate, these deposits are subject to potentially dramatic fluctuations in availability or price due to certain factors outside of our control, such as increasing competitive pressures for deposits, changes in interest rates and returns on other investment classes, customer perceptions of our financial health and general reputation, or a loss of confidence by customers in us or the banking sector generally, which could result in significant outflows of deposits within short periods of time or significant changes in pricing necessary to maintain current customer deposits or attract additional deposits. Additionally, any such loss of funds could result in lower loan originations, which could have a material adverse effect on our business, financial condition and results of operations.
Risk of the Competitive Environment in which We Operate
We face significant and increasing competition in the financial services industry.
The banking markets in which we operate are highly competitive and our future growth and success will depend on our ability to compete effectively in these markets. We compete for deposits, loans, and other financial services in our markets with commercial and community banks, credit unions, savings and loan associations, mortgage banking firms and online mortgage lenders, including large national financial institutions that operate in our market area. Many of these competitors are larger than us, have significantly more resources and greater brand recognition than we do, and may be able to attract customers more effectively than we can. Increased competition could require us to increase the rates we pay on deposits or lower the rates that we offer on loans, which could reduce our profitability. Our failure to compete effectively in our market could restrain our growth or cause us to lose market share, which could have a material adverse effect on our business, financial condition and results of operations.
Failure to keep pace with the rapid technological changes in the financial services industry could have a material adverse effect on our competitive position and profitability.
The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we have. We may not be able to implement new technology-driven products and services effectively or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could harm our ability to compete effectively and could have a material adverse effect on our business, financial condition or results of operations. As these technologies are improved in the future, we may be required to make significant capital expenditures in order to remain competitive, which may increase our overall expenses and have a material adverse effect on our business, financial condition and results of operations.
We may not be able to maintain growth, earnings or profitability consistent with our strategic plan.
There can be no assurance that we will remain profitable in future periods, or, if profitable, that our overall earnings will remain consistent with our prior results of operations, or increase in the future. Sustainable growth requires that we manage our risks by following prudent loan underwriting standards, balancing loan and deposit growth without materially increasing interest rate risk or compressing our net interest margin, maintaining more than adequate capital at all times, scaling technology platforms, hiring and retaining qualified employees, and successfully implementing our strategic initiatives. Our failure to maintain a sustainable rate of growth or adequately manage the factors that have contributed to that growth could have a material adverse effect on our earnings and profitability and, therefore on our business, financial condition and results of operations.
We may pursue strategic acquisitions in the future, and we may not be able to overcome risks associated with such transactions.
We may explore opportunities to invest in, or to acquire, other financial institutions and businesses that we believe would complement our existing business. Our investment or acquisition activities could be material to our business and involve a number of risks including the following: investing time and incurring expense associated with identifying and evaluating potential investments or acquisitions and negotiating potential transactions, resulting in our attention being diverted from the operation of our existing business; the lack of history among our management team in working together on acquisitions and related integration activities; the time, expense and difficulty of integrating the operations and personnel of the combined businesses; unexpected asset quality problems with acquired companies; inaccurate estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution or assets; risks of impairment to goodwill or other than temporary impairment of investment securities; potential exposure to unknown or contingent liabilities of banks and businesses we acquire; an inability to realize expected synergies or returns on investment; potential disruption of our ongoing banking business; and loss of key employees or key customers following our investment or acquisition.
We may not be successful in overcoming these risks or other problems encountered in connection with potential investments or acquisitions. Our inability to overcome these risks could have an adverse effect on our ability to implement our business strategy and enhance shareholder value, which, in turn, could have a material adverse effect on our business, financial condition or results of operations. Additionally, if we record goodwill in connection with any acquisition, our financial condition and results of operation may be adversely affected if that goodwill is subsequently determined to be impaired, which would require us to take an impairment charge.
New lines of business, products, product enhancements or services may subject us to additional risk.
From time to time, we may implement new lines of business or offer new products and product enhancements as well as new services within our existing lines of business. There are substantial risks and uncertainties associated with these efforts. In developing, implementing or marketing new lines of business, products, product enhancements or services, we may invest significant time and resources. We may underestimate the appropriate level of resources or expertise necessary to make new lines of business or products successful or to realize their expected benefits. We may not achieve the milestones set in initial timetables for the development and introduction of new lines of business, products, product enhancements or services, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also impact the ultimate implementation of a new line of business or offerings of new products, product enhancements or services. Any new line of business, product, product enhancement or service could have a significant impact on the effectiveness of our system of internal controls. We may also decide to discontinue businesses or products, due to lack of customer acceptance or unprofitability. Failure to successfully manage these risks in the development and implementation of new lines of business or offerings of new products, product enhancements or services could have a material adverse effect on our business, financial condition and results of operations.
Operational risks are inherent in our business.
Operational risks and losses can result from internal and external fraud; gaps or weaknesses in our risk management or internal control procedures; errors by employees or third-parties; failure to document transactions properly or to obtain proper authorization; failure to comply with applicable regulatory requirements; failures in the models we utilize and rely on; equipment failures, including those caused by electrical, telecommunications or other essential utility outages; business continuity and data security system failures, including those caused by computer viruses, cyberattacks, unforeseen problems encountered while implementing major new computer systems, upgrades to existing systems or inadequate access to data or poor response capabilities in light of such business continuity or data security system failures; or the inadequacy or failure of systems and controls, including those of our suppliers or counterparties. Although we have implemented risk controls and loss mitigation actions, and substantial resources are devoted to developing efficient procedures, identifying and rectifying weaknesses in existing procedures and training staff, there is no assurance that such actions will be effective in controlling all of the operational risks faced by us. Failure of our risk controls and/or loss mitigation actions could have a material adverse effect on our business, financial condition and results of operations.
We depend on information technology and telecommunications systems of third parties, and any systems failures or interruptions could adversely affect our operations and financial condition.
Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems. We outsource many of our major systems, such as data processing, deposit processing, loan origination, email and anti-money laundering monitoring systems. Of particular significance is our long-term contract for core data processing services with Fiserv. The failure of these systems, or the termination of a third party software license or service agreement on which any of these systems is based, could interrupt our operations, and we could experience difficulty in implementing replacement solutions. In many cases, our operations rely heavily on secured processing, storage and transmission of information and the monitoring of a large number of transactions on a minute-by-minute basis, and even a short interruption in service could have significant consequences. Because our information technology and telecommunications systems interface with and depend on third party systems, we could experience service denials if demand for such services exceeds capacity or such third party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could
have a material adverse effect on our business, financial condition and results of operations. In addition, failure of third parties to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of these third parties could disrupt our operations or adversely affect our reputation.
Risks Related to Risk Management
Our risk management framework may not be effective in mitigating risks and/or losses to us.
Our risk management framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, operational, interest rate and compliance. Our framework also includes financial or other modeling methodologies that involve management assumptions and judgment. Our risk management framework may not be effective under all circumstances. Our risk management framework may not adequately mitigate any risk or loss to us. If our risk management framework is not effective, we could suffer unexpected losses and our business, financial condition, results of operations or growth prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
If we fail to design, implement and maintain effective internal control over financial reporting or remediate any future material weakness in our internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud, which could have a material adverse effect on us.
Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of the financial reporting and the preparation of financial statements for external purposes in accordance with Generally Accepted Accounting Principles ("GAAP"). Effective internal control over financial reporting is necessary for us to provide reliable reports and prevent fraud.
Under Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), management is required to annually assess and report on the effectiveness of our internal control over financial reporting and, when we cease to be an emerging growth company under the JOBS Act, include an attestation report by the Company’s independent auditors addressing the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective due to the failure to cure any identified material weakness or otherwise. Moreover, even if management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm may conclude that our internal control over financial reporting is not effective. In the course of their review, our independent registered public accounting firm may not be satisfied with the internal control over financial reporting or the level at which the controls are documented, designed, operated or reviewed, or it may interpret the relevant requirements differently from the Company. In addition, during the course of the evaluation, documentation and testing of our internal control over financial reporting, we may identify deficiencies that we may not be able to remediate in time to meet the deadline imposed by the SEC for compliance with the requirements of the Sarbanes-Oxley Act. Any such deficiencies may also subject us to adverse regulatory consequences. If we fail to achieve and maintain the adequacy of internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may be unable to report our financial information on a timely basis, may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act, and may suffer adverse regulatory consequences or violate NASDAQ's listing standards. There could also be a negative reaction in the financial markets due to a loss of investor confidence in the reliability of our financial statements.
We believe that a control system, no matter how well designed and managed, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. We may not be able to identify all significant deficiencies and/or material weaknesses in our internal control in the future, and our failure to maintain effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act could have a material adverse effect on our business, financial condition and results of operations.
We, and third parties on which we rely, are subject to cybersecurity risks and security breaches and may incur increasing costs in an effort to minimize those risks and to respond to cyber incidents, and we may experience harm to our reputation and liability exposure from security breaches.
Our business involves the storage and transmission of customers' proprietary information, and security breaches could expose us to a risk of loss or misuse of this information, litigation and potential liability. While we have incurred no material cyber-attacks or security breaches to date, a number of other financial services and other companies have disclosed cyber-attacks and security breaches, some of which have involved intentional attacks. Attacks may be targeted at us, our customers, or both. Although we devote significant resources to maintain, regularly update and backup our systems and processes that are designed to protect the security of our computer systems, software, networks and other technology assets and the confidentiality, integrity and availability of information belonging to us or our customers, our security measures may not be effective against all potential cyber-attacks or security breaches. Despite our efforts to ensure the integrity of our systems, it is possible that we may not be able to anticipate or to implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently or are not recognized until launched, and because cyber-attacks can originate from a wide variety of sources. These risks may increase in the future as we continue to increase our internet-based product offerings and expand our internal usage of web-based products and applications. If an actual or perceived security breach occurs, customer perception of the effectiveness of our security measures could be harmed and could result in the loss of customers.
A successful penetration or circumvention of the security of our systems, including those of third party providers or other financial institutions, or the failure to meet regulatory requirements for security of our systems, could cause serious negative consequences, including significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage to our computers or systems or those of our customers or counterparties, significant increases in compliance costs (such as repairing systems or adding new personnel or protection technologies), and could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation and regulatory exposure, and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
We are dependent on the use of data and modeling in both our management's decision making generally, and in meeting regulatory expectations in particular.
The use of statistical and quantitative models and other quantitatively-based analyses is endemic to bank decision making and regulatory compliance processes, and the employment of such analyses is becoming increasingly widespread in our operations. Liquidity stress testing, interest rate sensitivity analysis, allowance for loan loss measurement, loan portfolio stress testing and the identification of possible violations of anti-money laundering regulations are examples of areas in which we are dependent on models and the data that underlies them. While these quantitative techniques and approaches improve our decision making, they also create the possibility that faulty data or flawed quantitative approaches could yield adverse outcomes or regulatory scrutiny. Secondarily, because of the complexity inherent in these approaches, misunderstanding or misuse of their outputs could similarly result in suboptimal decision making, which could have a material adverse effect on our business, financial condition and results of operations.
Regulatory, Compliance and Legal Risk
Our industry is highly regulated, and the regulatory framework, together with any future legislative or regulatory changes, may have a materially adverse effect on our operations.
The banking industry is highly regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, the public, the banking system as a whole or the FDIC Deposit Insurance Fund, not for the protection of our shareholders and creditors. Compliance with these laws and regulations can be difficult and costly, and changes to laws and regulations can impose additional compliance costs. The laws and regulations applicable to us govern a variety of matters, including permissible types, amounts and terms of loans and investments we may make, the maximum interest rate that may be charged, the types of deposits we may accept and the rates we may pay on such deposits, maintenance of adequate capital and liquidity, changes in control of us and our Bank, transactions between us and our Bank, handling of nonpublic information, restrictions on dividends and establishment of new offices. We must obtain approval from our regulators before engaging in certain activities, and there is risk that such approvals may not be granted, either in a timely manner or
at all. These requirements may constrain our operations, and the adoption of new laws and changes to or repeal of existing laws may have a further impact on our business, financial condition and results of operations. Also, the burden imposed by those federal and state regulations may place banks in general, including our Bank in particular, at a competitive disadvantage compared to their non-bank competitors. Our failure to comply with any applicable laws or regulations, or regulatory policies and interpretations of such laws and regulations, could result in sanctions by regulatory agencies, civil money penalties or damage to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
Bank holding companies and financial institutions are extensively regulated and currently face an uncertain regulatory environment. Applicable laws, regulations, interpretations, enforcement policies and accounting principles have been subject to significant changes in recent years, and may be subject to significant future changes. Future changes may have a material adverse effect on our business, financial condition and results of operations.
Federal and state regulatory agencies may adopt changes to their regulations or change the manner in which existing regulations are applied. We cannot predict the substance or effect of pending or future legislation or regulation or the application of laws and regulations to us. Compliance with current and potential regulation, as well as regulatory scrutiny, may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital, and limit our ability to pursue business opportunities in an efficient manner by requiring us to expend significant time, effort and resources to ensure compliance and respond to any regulatory inquiries or investigations.
In addition, regulators may elect to alter standards or the interpretation of the standards used to measure regulatory compliance or to determine the adequacy of liquidity, risk management or other operational practices for financial service companies in a manner that impacts our ability to implement our strategy and could affect us in substantial and unpredictable ways, and could have a material adverse effect on our business, financial condition and results of operations. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of laws and regulations and their assessment of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency's assessment of the quality of our assets, operations, lending practices, investment practices, capital structure or other aspects of our business differs from our assessment, we may be required to take additional charges or undertake, or refrain from taking, actions that could have a material adverse effect on our business, financial condition and results of operations.
We provide banking services to California-licensed cannabis businesses and the strict enforcement of federal laws regarding cannabis would likely result in our inability to continue this line of business and we could have legal action taken against us by the federal government.
We have launched a pilot program to provide deposit services to a limited number of California-licensed cannabis related businesses ("CRBs"). We will not be providing any extensions of credit under this program. Though medical and adult-use cannabis is legal in the state of California, its manufacture, distribution, possession, and use are prohibited under the federal Controlled Substances Act ("CSA"). Violations of the CSA are punishable by imprisonment and fines. Although there have been several examples of proposed federal legislation that would resolve the conflict between state and federal laws with respect to cannabis, no such legislation has passed to date.
In 2013, the U.S. Department of Justice ("DOJ") issued a memo ("Cole Memo") that outlined the DOJ's enforcement priorities with regard to cannabis and instructed federal prosecutors to focus prosecutorial efforts on eight priorities detailed in the memo. In 2018, the DOJ rescinded the Cole Memo and no subsequent guidance has been issued by the DOJ. In 2014, the U.S. Department of the Treasury's Financial Crimes Enforcement Network ("FinCEN") published guidelines as a response to the issuance of the Cole Memo to provide guidance for financial institutions servicing state legal cannabis businesses. The FinCEN guidance, which remains in effect, discusses federal regulators' expectations regarding the Bank Secrecy Act of 1970 compliance and due diligence protocols when a financial institution provides banking services to a CRB. Any adverse change to the FinCEN guidance or the interpretation of the guidance by federal regulators could cause us to immediately terminate our cannabis banking program. Any change in the enforcement priorities of the DOJ, FinCEN, or our federal banking regulators or our failure to comply with the FinCEN guidance could result in legal or administrative action being taken against us, and such action could have a material adverse effect on our business, financial condition and results of operations.
Regulatory requirements affecting our loans secured by commercial real estate could limit our ability to leverage our capital and adversely affect our growth and profitability.
The federal banking agencies have issued guidance for institutions that are deemed to have concentrations in CRE lending. Pursuant to the supervisory criteria contained in the relevant guidance, institutions which have (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution's total risk-based capital; or (ii) total CRE loans representing 300% or more of the institution's total risk-based capital and the outstanding balance of the institution's CRE loan portfolio has increased 50% or more during the prior 36 months are identified as having potential CRE concentration risk. Institutions which are deemed to have concentrations in CRE lending are expected to employ heightened levels of risk management with respect to their CRE portfolios, and may be required to hold higher levels of capital. We have a concentration in CRE loans, and multifamily residential real estate loans in particular, and we have experienced significant growth in our CRE portfolio in recent years. As of December 31, 2020, CRE loans represent 606% of the Company's total risk-based capital. Multifamily residential real estate loans, the vast majority of which are 50% risk weighted for regulatory capital purposes, were 575% of the Company's total risk-based capital. Management has extensive experience in CRE lending, and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to its CRE portfolio. Nevertheless, we could be required to maintain higher levels of capital as a result of our CRE concentration, which could limit our growth, require us to obtain additional capital, and have a material adverse effect on our business, financial condition and results of operations.
Litigation and regulatory actions, including possible enforcement actions, could subject us to significant fines, penalties, judgments or other requirements resulting in increased expenses or restrictions on our business activities.
In the normal course of business, from time to time, we have in the past and may in the future be named as a defendant in various legal actions, arising in connection with our current and/or prior business activities. Legal actions could include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. We may also, from time to time, be the subject of subpoenas, requests for information, reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding our current and/or prior business activities. Any such legal or regulatory actions may subject us to substantial compensatory or punitive damages, significant fines, penalties, obligations to change our business practices or other requirements resulting in increased expenses, diminished income and damage to our reputation. Our involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined in our favor, could also cause significant harm to our reputation and divert management attention from the operation of our business. Further, any settlement, consent order or adverse judgment in connection with any formal or informal proceeding or investigation by government agencies may result in litigation, investigations or proceedings as other litigants and government agencies begin independent reviews of the same activities. As a result, legal and regulatory actions could have a material adverse effect on our business, financial condition and results of operations.
Regulatory initiatives regarding bank capital requirements may require heightened capital.
Regulatory capital rules adopted in July 2013, which implement the Basel III regulatory capital reforms, include a common equity Tier 1 capital requirement and establish criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. These enhancements were intended to both improve the quality and increase the quantity of capital required to be held by banking organizations, and to better equip the U.S. banking system to deal with adverse economic conditions. The capital rules require bank holding companies and banks to maintain a common equity Tier 1 capital ratio of 4.5%, a minimum total Tier 1 risk based capital ratio of 6%, a minimum total risk based capital ratio of 8%, and a minimum leverage ratio of 4%. Bank holding companies and banks are also required to hold a capital conservation buffer of common equity Tier 1 capital of 2.5% to avoid limitations on capital distributions and discretionary executive compensation payments. The revised capital rules also require banks to maintain a common equity Tier 1 capital ratio of 6.5% or greater, a Tier 1 capital ratio of 8% or greater, a total capital ratio of 10% or greater and a leverage ratio of 5% or greater to be deemed "well-capitalized" for purposes of certain rules and prompt corrective action requirements. The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. As of December 31, 2020, we were in compliance with all applicable regulatory capital requirements, including the capital conservation buffer, and the Bank qualified as "well-capitalized" for purposes of the FDIC's prompt corrective action regulations. Future regulatory change could impose higher capital standards. Failure to maintain capital to meet current or future regulatory requirements could have a significant material adverse effect on our business, financial condition and results of operations.
We are subject to the anti-money laundering statutes and regulations, and failure to comply with these laws could lead to a wide variety of sanctions, damage our reputation and otherwise adversely affect our business.
The Bank Secrecy Act of 1970, the Uniting and Strengthening America by Providing Appropriate Tools to Intercept and Obstruct Terrorism Act of 2001 ("Patriot Act"), and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and to file reports such as suspicious activity reports and currency transaction reports. We are required to comply with these and other anti-money laundering requirements. Our federal and state banking regulators, FinCEN, and other government agencies are authorized to impose significant civil money penalties for violations of anti-money laundering requirements. We are also subject to increased scrutiny of compliance with the regulations issued and enforced by the Office of Foreign Assets Control ("OFAC"). If our program is deemed deficient, we could be subject to liability, including fines, civil money penalties and other regulatory actions, which may include restrictions on our business operations and our ability to pay dividends, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have significant reputational consequences for us. Any of these circumstances could have a material adverse effect on our business, financial condition or results of operations.
We are subject to numerous consumer protection laws, and failure to comply with these laws could lead to a wide variety of sanctions, damage our reputation and otherwise adversely affect our business.
The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations, including state laws and regulations, prohibit discriminatory lending practices by financial institutions. The Federal Trade Commission Act and the Dodd-Frank Act prohibit unfair, deceptive, or abusive acts or practices by financial institutions. We are also subject to complex and evolving laws and regulations governing the privacy and protection of personally identifiable information of individuals (including customers, employees, and other third parties), including, but not limited to, the Gramm-Leach-Bliley Act, and the California Consumer Protection Act. A challenge to an institution's compliance with these and other consumer protections laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Such actions could have a material adverse effect on our reputation, business, financial condition and results of operations.
Risk from Accounting Changes
We are subject to an extensive body of accounting rules and best practices. Periodic changes to such rules may change the treatment and recognition of critical financial line items and affect our profitability.
The nature of our business makes us sensitive to the large body of accounting rules in the U.S. From time to time, the governing bodies that oversee changes to accounting rules and reporting requirements may release new guidance for the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some instances, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. These changes could adversely affect our capital, regulatory capital ratios, ability to make larger loans, earnings and performance metrics. We are evaluating the impact the CECL accounting model will have on our financial results, but expect to recognize a one-time cumulative-effect adjustment to the allowance for loan losses and retained earnings as of the beginning of the first reporting period in which the new standard is effective. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our financial condition or results of operations. Any such changes could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to an Investment in Our Common Stock
We are controlled by trusts established for the benefit of members of the Trione family, whose interests in our business may be different from yours.
As of December 31, 2020, the Trione Family Trusts control 76.7% of our common stock and if they vote in the same manner, are able to determine the outcome of all matters put to a shareholder vote, including the election of directors, the approval of mergers, material acquisitions and dispositions and other extraordinary transactions, and
amendments to our articles of incorporation, bylaws and other corporate governance documents. So long as the Trione Family Trusts continue to own a majority of our common stock, they will have the ability, if they vote in the same manner, to prevent any transaction that requires shareholder approval regardless of whether others believe the transaction is in our best interests. In any of these matters, the interests of the Trione Family Trusts may differ from or conflict with the interests of our other shareholders. Moreover, this concentration of stock ownership may also adversely affect the trading price of our common stock, if investors perceive disadvantages in owning stock of a company with a controlling group.
We may discontinue the payment of dividends on, or repurchases of, our common stock.
Our stockholders are only entitled to receive such dividends as our Board may declare out of funds legally available for such payments. In October 2020, our Board authorized us to repurchase up to $20.0 million of our common stock. We are not required to pay dividends on, or effect repurchases of, our common stock and may reduce or eliminate our common stock dividend and/or share repurchase program in the future. Our ability to pay dividends to our stockholders is subject to the restrictions set forth in Delaware law, by the Federal Reserve, and by certain covenants contained in our subordinated debentures. Notification to the Federal Reserve is also required prior to our declaring and paying a cash dividend to our stockholders during any period in which our quarterly and/or cumulative twelve-month net earnings are insufficient to fund the dividend amount, among other requirements. We may not pay a dividend if the Federal Reserve objects or until such time as we receive approval from the Federal Reserve or we no longer need to provide notice under applicable regulations. In addition, we may be restricted by applicable law or regulation or actions taken by our regulators, now or in the future, from paying dividends to, or repurchasing shares of our common stock from, our stockholders. We cannot provide assurance that we will continue paying dividends on, or repurchase shares of, our common stock at current levels or at all. A reduction or discontinuance of dividends on our common stock or our share repurchase program could have a material adverse effect on our business, including the market price of our common stock.
Item 1B. Unresolved Staff Comments
Item 2. Properties
Our corporate headquarters is located at 520 Third Street, Santa Rosa, California. In addition to our corporate headquarters, the Bank operates ten full service branches in California located in Sonoma, Marin, Santa Clara, and Los Angeles Counties and one full service branch in Washington located in King County. We also operate six loan production offices located throughout California, as well as a loan production office in Clackamas County, Oregon. Other than our main branch in Santa Rosa, California, which we own, we lease all of our other offices.
Item 3. Legal Proceedings
From time to time, we are party to legal actions that are routine and incidental to our business. Given the nature, scope and complexity of the extensive legal and regulatory landscape applicable to our business, we, like all banking organizations, are subject to heightened regulatory compliance and legal risk. However, based on available information, management does not expect the ultimate disposition of any or a combination of these actions to have a material adverse effect on our business, financial condition or results of operations.
Item 4. Mine Safety Disclosures
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Holders of Record
Our common stock is listed on the NASDAQ Global Select Stock Market under the trading symbol "LBC". As of March 1, 2021, we had approximately 1,756 record holders. On March 1, 2021 our stock closed at $10.62.
Stock Performance Graph
The performance graph and table below compare the cumulative total stockholder return on the common stock of the Company with the cumulative total return on the equity securities included in (i) the Russell 2000 Index, which measures the performance of the smallest 2,000 members by market cap of the Russell Index, (ii) the SNL Western U.S. Bank Index, which reflects the performance of publicly traded U.S. companies that do business as banks in the Western U.S., and (iii) the SNL U.S. Bank and Thrift Index, which reflects the performance of publicly traded U.S. companies that do business as regional banks or thrifts. During the year ended December 31, 2020, the Company decided to add the SNL Western U.S. Bank Index because management believes that comparing the Company's stock performance to the stock performance of other publicly traded industry participants operating in the Company's primary geographic markets is meaningful.
The graph assumes an initial $100 investment on December 8, 2017, the date that the stock of the Company began trading on the NASDAQ Global Select Stock Market through December 31, 2020, the final trading day of 2020. Data for the Russell 2000, the SNL Western U.S. Bank and the SNL U.S. Bank and Thrift indices assume reinvestment of dividends. Returns are shown on a total return basis. The performance graph represents past performance and should not be considered to be an indication of future performance. This graph is not deemed filed with the SEC.
|Luther Burbank Corporation||100.00 ||102.47 ||102.33 ||98.48 ||93.63 ||78.09 ||87.95 ||95.36 ||99.76 ||102.03 ||81.57 ||89.54 ||75.21 ||88.78 |
|Russell 2000 Index||100.00 ||101.03 ||100.95 ||108.78 ||112.67 ||89.91 ||103.02 ||105.18 ||102.65 ||112.85 ||78.30 ||98.21 ||103.05 ||135.38 |
|SNL Western U.S. Bank Index||100.00 ||101.92 ||92.1 ||97.67 ||94.3 ||80.7 ||85.8 ||85.75 ||89.98 ||98.41 ||56.10 ||56.69 ||53.06 ||72.63 |
|SNL U.S. Bank and Thrift Index||100.00 ||100.50 ||99.52 ||98.30 ||100.08 ||83.49 ||90.69 ||96.13 ||98.84 ||112.83 ||67.47 ||74.47 ||72.76 ||97.90 |
|Source: S&P Global Market Intelligence|
Holders of our common stock are only entitled to receive dividends when, and if, declared by our board of directors out of funds legally available for dividends.
Any future determination relating to our dividend policy will be made by our board of directors and will depend on a number of factors, including general and economic conditions, industry standards, our financial condition and operating results, our available cash and current and anticipated cash needs, capital requirements, our ability to service debt obligations senior to our common stock, banking regulations, contractual, legal, tax and regulatory restrictions, and limitations on the payment of dividends by us to our shareholders or by the Bank to us, and such other factors as our board of directors may deem relevant.
Because we are a bank holding company and do not engage directly in business activities of a material nature, our ability to pay any dividends on our common stock depends, in large part, upon our receipt of dividends from our Bank, which is also subject to numerous limitations on the payment of dividends under federal and state banking laws, regulations and policies.
Subject to the discretion of our board of directors, commencing in the second quarter of 2018, the Company established a regular quarterly cash dividend on our common stock of $0.0575 per share. Although we currently intend to pay dividends according to our dividend policy, there can be no assurance that we will pay any dividend to holders of our stock, or as to the amount of any such dividends. Our board of directors, in its sole discretion, can change the amount or frequency of this dividend or discontinue the payment of dividends entirely at any time.
The following table shows the dividends that have been declared on our common stock with respect to the periods indicated below. The per share amounts are presented to the nearest cent.
|(dollars in thousands except per share data)||Amount Per Share||Total Cash Dividend|
|Quarter ended March 31, 2019||$||0.06 ||$||3,294 |
|Quarter ended June 30, 2019||0.06 ||3,267 |
|Quarter ended September 30, 2019||0.06 ||3,234 |
|Quarter ended December 31, 2019||0.06 ||3,237 |
|Quarter ended March 31, 2020||0.06 ||3,240 |
|Quarter ended June 30, 2020||0.06 ||3,038 |
|Quarter ended September 30, 2020||0.06 ||3,022 |
|Quarter ended December 31, 2020||0.06 ||3,014 |
Dividend Limitations. California law places limits on the amount of dividends the Bank may pay to the Company without prior approval. Prior regulatory approval is required to pay dividends which exceed the lesser of the Bank’s retained earnings or the Bank’s retained net income for the prior three fiscal years. State and federal bank regulatory agencies also have authority to prohibit a bank from paying dividends if such payment is deemed to be an unsafe or unsound practice, and the Federal Reserve has the same authority over bank holding companies. We would not be able to pay a dividend in excess of our retained earnings, or where our liabilities would exceed our assets.
The Federal Reserve has established requirements with respect to the maintenance of appropriate levels of capital by registered bank holding companies. Compliance with such standards, as presently in effect, or as they may be amended from time to time, could possibly limit the amount of dividends that we may pay in the future. The Federal Reserve has issued guidance on the payment of cash dividends by bank holding companies. In the statement, the Federal Reserve expressed its view that a holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income, or which could only be funded in ways that weaken the holding company’s financial health, such as by borrowing. Under Federal Reserve guidance, as a general matter, the Board of Directors of a holding company should inform the Federal Reserve and should eliminate, defer, or significantly reduce the dividends if: (i) the holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the holding company’s prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or (iii) the holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. As a depository institution, the deposits of which are insured by the FDIC, the Bank may not pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Bank currently is not in default under any of its obligations to the FDIC.
Purchases of Equity Securities
The table below summarizes the Company's monthly repurchases of equity securities during the quarter ended December 31, 2020 (dollars in thousands, except per share data):
|Period||Total Number of Shares Purchased||Average Price Paid Per Share||Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)||Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or Program (1)|
|October 1 - 31, 2020||— ||$||— ||— ||$||— |
|November 1 - 30, 2020||149,360 ||9.52 ||149,360 ||18,579 |
|December 1 - 31, 2020||— ||— ||— ||18,579 |
|Total||149,360 ||$||9.52 ||149,360 ||$||18,579 |
(1) On October 30, 2020, the Board of Directors of the Company authorized the repurchase of $20.0 million of the Company’s common stock pursuant to a formal program adopted on that date (the “Plan”). The Plan has been adopted in accordance with guidelines specified by Rule 10b5-1 and under Rule 10b-18 under the Securities Exchange Act of 1934, as amended, and the Company’s Insider Trading Policy. The Plan is effective from November 2, 2020 until December 31, 2021. The Plan was announced by Current Report on Form 8-K on November 2, 2020.
Shares Eligible for Sale Pursuant to Rule 144
An aggregate of 35.8 million shares of common stock held by the Trione Family Trusts, which were issued in private transactions, are eligible for sale in accordance with Rule 144 under the Securities Act.
Item 6. Selected Financial Data
The following table sets forth the Company’s selected historical consolidated financial data for the years and as of the dates indicated. You should read this information together with Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Company’s audited consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of and for the years ended December 31, 2020 and 2019 are derived from our audited consolidated financial statements, which are included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of and for the years ended December 31, 2018, 2017 and 2016 (except as otherwise noted below) are derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The Company’s historical results for any prior period are not necessarily indicative of future performance.
|(Dollars in thousands, except per share data)||As of or For the Years Ended December 31,|
|Statements of Income and Financial Condition Data|
|Net income||$||39,912 ||$||48,861 ||$||45,060 ||$||69,384 ||$||52,121 |
|Pre-tax, pre-provision net earnings (1)||$||67,209 ||$||70,714 ||$||66,531 ||$||61,859 ||$||41,237 |
|Total assets||$||6,906,104 ||$||7,045,828 ||$||6,937,212 ||$||5,704,380 ||$||5,063,585 |
|Per Common Share (2)|
|Diluted earnings per share||$||0.75 ||$||0.87 ||$||0.79 ||$||1.62 ||$||1.24 |
|Book value per share||$||11.75 ||$||10.97 ||$||10.31 ||$||9.74 ||$||9.63 |
|Tangible book value per share (1)||$||11.69 ||$||10.91 ||$||10.25 ||$||9.68 ||$||9.55 |
|Actual/Pro Forma Net Income and Per Common Share Data (1)|
|Actual/pro forma net income||$||39,912 ||$||48,861 ||$||45,060 ||$||37,834 ||$||31,285 |
|Actual/pro forma diluted earnings per share (2)||$||0.75 ||$||0.87 ||$||0.79 ||$||0.88 ||$||0.74 |
|Return on average:|
|Assets ||0.56 ||%||0.69 ||%||0.70 ||%||1.26 ||%||1.11 ||%|
|Stockholders' equity ||6.53 ||%||8.15 ||%||7.96 ||%||16.30 ||%||13.35 ||%|
|Dividend payout ratio||30.85 ||%||26.67 ||%||35.43 ||%||97.72 ||%||32.23 ||%|
|Net interest margin||1.97 ||%||1.84 ||%||1.98 ||%||2.05 ||%||2.04 ||%|
|Efficiency ratio (1)||52.38 ||%||46.86 ||%||48.51 ||%||47.76 ||%||59.76 ||%|
|Noninterest expense to average assets||1.04 ||%||0.88 ||%||0.98 ||%||1.03 ||%||1.31 ||%|
|Loan to deposit ratio||114.92 ||%||119.03 ||%||122.59 ||%||127.59 ||%||133.17 ||%|
|Actual/Pro Forma Selected Ratios (1)|
|Actual/pro forma return on average assets||0.56 ||%||0.69 ||%||0.70 ||%||0.69 ||%||0.67 ||%|
|Actual/pro forma return on average stockholders' equity||6.53 ||%||8.15 ||%||7.96 ||%||8.89 ||%||8.02 ||%|
|Credit Quality Ratios|
|Allowance for loan losses to loans||0.76 ||%||0.58 ||%||0.56 ||%||0.60 ||%||0.75 ||%|
|Allowance for loan losses to nonperforming loans||732.04 ||%||568.47 ||%||1,705.47 ||%||437.91 ||%||1,251.80 ||%|
|Nonperforming assets to total assets||0.09 ||%||0.09 ||%||0.03 ||%||0.12 ||%||0.05 ||%|
|Net charge-offs (recoveries) to average loans||0.01 ||%||(0.01)||%||(0.01)||%||(0.01)||%||(0.01)||%|
|Tier 1 leverage ratio||9.45 ||%||9.47 ||%||9.42 ||%||11.26 ||%||9.47 ||%|
|Total risk-based capital ratio ||18.60 ||%||17.97 ||%||17.20 ||%||18.78 ||%||18.58 ||%|
(1) Considered a non-GAAP financial measure. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ‘‘Non-GAAP Financial Measures’’ for a reconciliation of our non-GAAP measures to the most directly comparable GAAP financial measure. Tangible book value is defined as total assets less goodwill and total liabilities. Efficiency ratio is defined as the ratio of noninterest expense to net interest income plus noninterest income. Pre-tax, pre-provision net earnings is defined as net income before taxes and provision for loan losses. For periods prior to January 1, 2018, we calculate our pro forma net income, return on average assets and return on average stockholders' equity by adding back our franchise S-Corporation tax to net income, and using a combined C-Corporation effective tax rate for federal and California income taxes of 42.0%. This calculation reflects only the change in our status as an S-Corporation and does not give effect to any other transaction. Beginning January 1, 2018, our pro forma provision for tax expense is our actual C-Corporation provision.
|(2) Earnings per common share, basic and diluted, book value per common share and actual/pro forma diluted earnings per share have been adjusted retroactively to reflect a 200-for-1 stock split effective April 27, 2017.|
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis is based on and should be read in conjunction with Part II. Item 6. Selected Financial Data and our consolidated financial statements and the accompanying notes thereto contained elsewhere in this Annual Report on Form 10-K. However, because we conduct all of our material business operations through our bank subsidiary, Luther Burbank Savings, the discussion and analysis relates to activities primarily conducted by the Bank.
The following discussion and analysis is intended to facilitate the understanding and assessment of significant changes and trends in our business that accounted for the changes in our results of operations for the year ended December 31, 2020, as compared to our results of operations for the year ended December 31, 2019, and our financial condition at December 31, 2020 as compared to our financial condition at December 31, 2019.
In addition to historical information, this discussion and analysis contains forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that we believe are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth in the “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors” sections of this Annual Report, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. Please read these sections carefully. We assume no obligation to update any of these forward-looking statements.
We are a bank holding company headquartered in Santa Rosa, California, and the parent company of Luther Burbank Savings, a California-chartered commercial bank headquartered in Gardena, California with $6.9 billion in assets at December 31, 2020. Our principal business is providing high-value, relationship-based banking products and services to our customers, which include real estate investors, professionals, entrepreneurs, depositors and commercial businesses. We generate most of our revenue from interest on loans and investments. Our primary source of funding for our loans is retail deposits and we place secondary reliance on wholesale funding, primarily borrowings from the FHLB and brokered deposits. Our largest expenses are interest on deposits and borrowings along with salaries and related employee benefits. Our principal lending products are real estate secured loans, consisting primarily of multifamily residential properties and jumbo single family residential properties on the West Coast.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP and with general practices within the financial services industry. Application of these principles requires management to make complex and subjective estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances. These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates. Actual results may differ from these estimates.
Our most significant accounting policies are described in Note 1 to our Financial Statements for the year ended December 31, 2020. We have identified the following accounting policies and estimates that, due to the difficult, subjective or complex judgments and assumptions inherent in those policies and estimates and the potential sensitivity of our financial statements to those judgments and assumptions, are critical to an understanding of our financial condition and results of operations. We believe that the judgments, estimates and assumptions used in the preparation of our financial statements are reasonable and appropriate.
Pursuant to the JOBS Act, as an emerging growth company, we can elect to opt out of the extended transition period for adopting any new or revised accounting standards. We have elected not to opt out of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we may adopt the standard for the private company.
We have elected to take advantage of the scaled disclosures and other relief under the JOBS Act, and we may take advantage of some or all of the reduced regulatory and reporting requirements that will be available to us under the JOBS Act, so long as we qualify as an emerging growth company.
Allowance for Loan Losses
The allowance for loan losses is provided for probable incurred credit losses inherent in the loan portfolio at the statement of financial condition date. The allowance is increased by a provision charged to expense and reduced by loan principal charge-offs, net of recoveries. Where management determines that the allowance for loan losses is more than adequate to absorb the probable incurred credit losses in the portfolio, the allowance is reduced by recapturing provisions and a credit is made to the expense account. The allowance is based on management’s assessment of various factors including, but not limited to, the nature of the loan portfolio, previous loss experience, known and inherent risks in the portfolio, the estimated value of underlying collateral, information that may affect a borrower’s ability to repay, current economic conditions and the results of our ongoing reviews of the portfolio. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance. Such agencies may require the Bank to recognize additions to the allowance based on judgments
different from those of management.
While we use available information, including independent appraisals for collateral, to estimate the extent of probable incurred loan losses within the loan portfolio, inherent uncertainties in the estimation process make it reasonably possible that ultimate losses may vary significantly from our original estimates. Generally, loans are partially or fully charged off when it is determined that the unpaid principal balance exceeds the current fair value of the collateral with no other likely source of repayment. In addition, the estimates utilized to determine the appropriate allowance for loan losses at December 31, 2020 may be materially different from actual results due to the COVID-19 pandemic.
Fair Value Measurement
We use estimates of fair value in applying various accounting standards for our consolidated financial statements. Fair value is defined as the exit price at which an asset may be sold or a liability may be transferred in an orderly transaction between willing and able market participants. When available, fair value is measured by looking at observable market prices for identical assets and liabilities in an active market. When these are not available, other inputs are used to model fair value such as prices of similar instruments, yield curves, prepayment speeds and credit spreads. Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.
Changes in the fair value of debt securities available for sale and derivatives designated as effective cash flow hedges are recorded in our consolidated statements of financial condition and comprehensive income (loss) while changes in the fair value of equity securities, loans held for sale or other derivatives are recorded in the consolidated statements of financial condition and in the consolidated statements of income.
Investment Securities Impairment
We assess, on a quarterly basis, whether there have been any events or economic circumstances to indicate that a security in which we have an unrealized loss is impaired on an other than temporary basis. In any instance, we would consider many factors, including the severity and duration of the impairment, the portion of any unrealized loss attributable to a decline in the credit quality of an issuer, our intent and ability to hold the security for a period of time sufficient for a recovery in value, recent events specific to the issuer or industry, and, for debt securities, external credit ratings and recent downgrades. Securities with respect to which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value.
Non-GAAP Financial Measures
Some of the financial measures discussed in Item 6. Selected Financial Data and Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation are ‘‘non-GAAP financial measures.’’ In accordance with SEC rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our consolidated statements financial condition, income or cash flows.
Pre-tax, pre-provision net earnings is defined as net income before taxes and provision for (reversal of) loan losses. We believe the most directly comparable GAAP financial measure is income before taxes. Disclosure of this measure enables you to compare our operations to those of other banking companies before consideration of taxes and provision expense, which some investors may consider to be a more appropriate comparison given our S-Corporation status in prior years and recaptures from the allowance for loan losses. Prior to January 1, 2018, we calculate our pro forma net income, return on average assets, return on average equity and per share amounts by adding back our franchise S-Corporation tax to net income, and using a combined C-Corporation effective tax rate for federal and California income taxes of 42.0%. This calculation reflects only the change in our status as an S-Corporation and does not give effect to any other transaction. Beginning January 1, 2018, our pro forma income tax expense is our actual C-Corporation tax provision. Tangible book value is defined as total assets less goodwill and total liabilities. Efficiency ratio is defined as noninterest expenses divided by operating revenue, which is equal to net interest income plus noninterest income. For the year ended December 31, 2020, we calculated a pro forma net income and efficiency ratio to reverse the impact of a material non-recurring cost incurred in connection with the prepayment of long-term FHLB borrowings. We believe that these non-GAAP financial measures provide useful
information to management and investors that is supplementary to our consolidated statements of financial condition, income and cash flows computed in accordance with GAAP. However, we acknowledge that our non-GAAP financial measures have a number of limitations. As such, you should not view these disclosures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP financial measures that other banking companies use. Other banking companies may use names similar to those we use for the non-GAAP financial measures we disclose, but may calculate them differently. You should understand how we and other companies each calculate their non-GAAP financial measures when making comparisons.
The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:
|(Dollars in thousands except per share data)||As of or For the Years Ended December 31,|
|Pre-tax, Pre-provision Net Earnings|
|Income before provision for income taxes||$||56,659 ||$||69,464 ||$||62,931 ||$||65,231 ||$||53,940 |
|Plus: Provision for (reversal of) loan losses||10,550 ||1,250 ||3,600 ||(3,372)||(12,703)|
|Pre-tax, pre-provision net earnings||$||67,209 ||$||70,714 ||$||66,531 ||$||61,859 ||$||41,237 |
|Noninterest expense (numerator)||$||73,934 ||$||62,368 ||$||62,687 ||$||56,544 ||$||61,242 |
|Net interest income||138,623 ||128,407 ||125,087 ||110,895 ||94,594 |
|Noninterest income||2,520 ||4,675 ||4,131 ||7,508 ||7,885 |
|Operating revenue (denominator) ||$||141,143 ||$||133,082 ||$||129,218 ||$||118,403 ||$||102,479 |
|Efficiency ratio||52.38 ||%||46.86 ||%||48.51 ||%||47.76 ||%||59.76 ||%|
Pro Forma Efficiency Ratio (1)
|Noninterest expense||$||73,934 |
|Less: Non-recurring noninterest expense item, before income taxes||(10,443)|
|Pro forma noninterest expense (numerator)||$||63,491 |
|Operating revenue (denominator)||$||141,143 |
|Pro forma efficiency ratio||44.98 ||%|
Pro Forma Net Income (1)
|Net income||$||39,912 |
|Add: Non-recurring noninterest expense item, net income taxes||7,352 |
|Pro forma net income||$||47,264 |
Actual/Pro Forma Net Income (2)
|Income before provision for income taxes||$||56,659 ||$||69,464 ||$||62,931 ||$||65,231 ||$||53,940 |
|Actual/pro forma provision for income taxes||16,747 ||20,603 ||17,871 ||27,397 ||22,655 |
|Actual/pro forma net income (numerator)||$||39,912 ||$||48,861 ||$||45,060 ||$||37,834 ||$||31,285 |
Actual/Pro Forma Diluted Earnings Per Share (2)
Weighted average common shares outstanding - diluted (denominator) (3)
|53,146,298 ||56,219,892 ||56,825,402 ||42,957,936 ||42,000,000 |
|Actual/pro forma diluted earnings per share||$||0.75 ||$||0.87 ||$||0.79 ||$||0.88 ||$||0.74 |
Actual/Pro Forma Return on Average Assets (2)
Actual/pro forma net income (numerator)
|$||39,912 ||$||48,861 ||$||45,060 ||$||37,834 ||$||31,285 |
|Average assets (denominator)||$||7,092,407 ||$||7,066,547 ||$||6,405,931 ||$||5,485,832 ||$||4,676,676 |
|Actual/pro forma return on average assets||0.56 ||%||0.69 ||%||0.70 ||%||0.69 ||%||0.67 ||%|
Actual/Pro Forma Return on Average Stockholders' Equity (2)
Actual/pro forma net income (numerator)
|$||39,912 ||$||48,861 ||$||45,060 ||$||37,834 ||$||31,285 |
|Average stockholders' equity (denominator)||$||610,770 ||$||599,574 ||$||566,275 ||$||425,698 ||$||390,318 |
|Actual/pro forma return on average stockholders' equity||6.53 ||%||8.15 ||%||7.96 ||%||8.89 ||%||8.02 ||%|
|(Dollars in thousands except per share data)||As of or For the Years Ended December 31,|
|Tangible Book Value Per Share|
|Total assets||$||6,906,104 ||$||7,045,828 ||$||6,937,212 ||$||5,704,380 ||$||5,063,585 |
|Tangible assets||6,902,807 ||7,042,531 ||6,933,915 ||5,701,083 ||5,060,288 |
|Less: Total liabilities||(6,292,413)||(6,431,364)||(6,356,067)||(5,154,635)||(4,659,210)|
|Tangible stockholders' equity (numerator)||$||610,394 ||$||611,167 ||$||577,848 ||$||546,448 ||$||401,078 |
Period end shares outstanding (denominator) (3)
|52,220,266 ||55,999,754 ||56,379,066 ||56,422,662 ||42,000,000 |
|Tangible book value per share||$||11.69 ||$||10.91 ||$||10.25 ||$||9.68 ||$||9.55 |
(1) For the year ended December 31, 2020, net income and efficiency ratio are adjusted to reverse the impact of a non-recurring cost incurred in connection with the prepayment of $150 million of long-term FHLB advances in December 2020.
(2) For periods prior to January 1, 2018, we calculate our pro forma net income, return on average assets and return on average stockholders' equity by adding back our franchise S-Corporation tax to net income, and using a combined C-Corporation effective tax rate for federal and California income taxes of 42.0%. This calculation reflects only the change in our status as an S-Corporation and does not give effect to any other transaction. Beginning January 1, 2018, our pro forma provision for tax expense is our actual C-Corporation provision.
(3) Weighted average common shares outstanding - diluted and period end shares outstanding have been adjusted retroactively to reflect a 200-for-1 stock split effective April 27, 2017.
Key Factors Affecting Our Business
Net interest income is the largest contributor to our net income and is the difference between the interest and fees earned on interest-earning assets and the interest expense incurred in connection with interest-bearing liabilities. Net interest income is primarily a function of the average balances and yields of these interest-earning assets and interest-bearing liabilities. These factors are influenced by internal considerations such as product mix and risk appetite, as well as external influences such as economic conditions, competition for loans and deposits and market interest rates.
The cost of our deposits and short-term wholesale borrowings is primarily based on short-term interest rates, which are largely driven by the Federal Reserve’s actions and market competition. The yields generated by our loans and securities are typically affected by short-term and long-term interest rates, which are driven by market competition and market rates often impacted by the Federal Reserve’s actions. The level of net interest income is influenced by movements in such interest rates and the pace at which such movements occur.
Based on our liability sensitivity as discussed in Item 7A. ‘‘Quantitative and Qualitative Disclosures About Market Risk’’, significant increases in interest rates and/or a flatter yield curve could have an adverse impact on our net interest income. Conversely, significant decreases in interest rates, particularly at the short end, and/or a steepened yield curve would be expected to benefit our net interest income.
We have invested significantly in our infrastructure, including our management, lending teams, technology systems and risk management practices. As we have begun to leverage these investments, our efficiency has generally improved.
We have well established loan policies and underwriting practices that have resulted in very low levels of charge-offs and nonperforming assets. We strive to originate quality loans that will maintain the credit quality of our loan portfolio. However, credit trends in the markets in which we operate are largely impacted by economic conditions beyond our control and can adversely impact our financial condition and results of operations.
The industry and businesses in which we operate are highly competitive. We may see increased competition in different areas including interest rates, underwriting standards and product offerings and loan structure. While we seek to maintain an appropriate return on our investments, we may experience continued pressure on our net
interest margin as we operate in this competitive environment.
Our business and financial performance are affected by economic conditions generally in the United States and more directly in the markets of California, Washington and Oregon where we operate. The significant economic factors that are most relevant to our business and our financial performance include, but are not limited to, real estate values, interest rates and unemployment rates.
Factors Affecting Comparability of Financial Results
We terminated our status as a “Subchapter S” corporation as of December 1, 2017, in connection with our IPO. Prior to this date, we elected to be taxed for U.S. federal income tax purposes as an S-Corporation. As a result, our earnings were not subject to, and we did not pay, U.S. federal income tax, and we were not required to make any provision or recognize any liability for U.S. federal income tax in our financial statements. While we were not subject to and did not pay U.S. federal income tax, we were subject to, and paid, California S-Corporation income tax at a rate of 3.50%.
Upon the termination of our status as an S-Corporation on December 1, 2017, we commenced paying U.S. federal income tax and a higher California income tax on our taxable earnings and our financial statements reflect a provision for both U.S. federal income tax and California income tax. As a result of this change, the net income and earnings per share data presented in our historical financial statements and the other financial information set forth in this Annual Report, which unless otherwise specified, do not include any provision for U.S. federal income tax, will not be comparable with our net income and earnings per share in periods after we commenced being taxed as a C-Corporation. As a C-Corporation, our net income is calculated by including a provision for U.S. federal income tax, currently at 21.00%, and a California income tax rate, currently at 10.84%.
As an S-Corporation, we made quarterly cash distributions to our shareholders in amounts estimated by us to be sufficient for them to pay estimated individual U.S. federal and California income tax liabilities resulting from our taxable income that was ‘‘passed through’’ to them. However, these distributions were not consistent, as sometimes the distributions were less than or in excess of the shareholders' estimated U.S. federal and California income tax liabilities resulting from their ownership of our stock. In addition, these estimates were based on individual income tax rates, which may differ from the rates imposed on the income of C-Corporations. Subsequent to the termination of our S-Corporation status on December 1, 2017, other than our obligations under the tax sharing agreement with prior S-Corporation shareholders, no further income will be ‘‘passed through’’ to shareholders for any estimated tax liabilities.
Deferred tax assets and liabilities are recognized for the tax consequences attributable to differences between the financial statement carrying amounts of our existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
Multifamily Securitization Transaction
During 2017, we entered into a trust sale memorandum of understanding with Freddie Mac, pursuant to which we agreed to sell a portfolio of multifamily loans to a real estate mortgage investment conduit ("REMIC"), that holds the loans in trust and issued securities that are fully guaranteed by Freddie Mac and privately offered and sold to investors. On September 27, 2017, we closed this securitization transaction. We did not purchase any of the securities for our portfolio.
The primary purpose of this multifamily securitization transaction was to enable us to redeploy capital and funding to support higher-yielding assets while also reducing our reliance on wholesale funding, improving liquidity measures and reducing our concentration of multifamily loans.
The size of the multifamily loan portfolio sold to the REMIC was $626.1 million, consisting of one class of post-reset, variable rate 3, 5, and 7-year hybrid loans in an aggregate principal amount of approximately $91.6 million, and two classes of pre-reset, variable rate 3, 5 and 7-year hybrid loans in an aggregate principal amount of approximately $534.5 million. 74.3% of the loan portfolio consisted of loans for multifamily properties located in California, while the remaining 25.7% of the loan portfolio consisted of loans for multifamily properties located in Washington. We
retained sub-servicing obligations on the loan portfolio. The gross proceeds of this sale to us was approximately $637.6 million. We used the proceeds of this sale to pay down short-term FHLB borrowings. These borrowings had no prepayment penalties associated with them. The following table summarizes the loans that were sold in this securitization.
|(Dollars in thousands)||Number of Mortgage Loans (1)||Principal Balance (1)||Percentage of Mortgage Pool Balance||Weighted Average Mortgage Rate (1)||Loan to Value Ratio (1)||Debt Service Coverage Ratio (1)|
|Post-Reset Hybrid Loans||65 ||$||91,552 ||14.6 ||%||3.66 ||%||53.2 ||%||1.88 |
|Pre-Reset Hybrid Loans (2)||237 ||415,628 ||66.4 ||%||3.39 ||%||54.2 ||%||1.67 |
|Pre-Reset Hybrid Loans (3)||70 ||118,880 ||19.0 ||%||3.51 ||%||46.5 ||%||1.70 |
|Total||372 ||$||626,060 ||100.0 ||%||3.45 ||%||52.6 ||%||1.71 |
i.Represents number of loans, balance, weighted average rate and ratios at the security cut-off date of September 1, 2017.
ii.Loans had 1 to 40 months until their first rate reset at the security cut-off date of September 1, 2017.
iii.Loans had 41 or more months until their first rate reset at the security cut-off date of September 1, 2017.
In connection with the securitization, we entered into a reimbursement agreement with Freddie Mac, pursuant to which we are obligated to reimburse Freddie Mac for the first losses in the underlying loan portfolio not to exceed 10% of the unpaid principal amount of the loans comprising the securitization pool at settlement, or approximately $62.6 million. Our reimbursement obligation is supported by a FHLB letter of credit. Our reimbursement obligation will terminate on the later of (i) the date on which Freddie Mac has no further liability (accrued or contingent) under its guarantee for these securities or (ii) the date on which we shall pay to Freddie Mac our full reimbursement obligation. As of December 31, 2020, the aggregate remaining loan balance in the securitization loans was $199.0 million. No disbursements have been made in connection with the reimbursement obligation.
Public Company Costs
As a result of our initial public offering completed in December 2017, we are incurring additional costs associated with operating as a public company. These costs include additional personnel, legal, consulting, regulatory, insurance, accounting, investor relations and other expenses that we did not incur as a private company.
The Sarbanes-Oxley Act, as well as rules adopted by the SEC and national securities exchanges, requires public companies to implement specified corporate governance practices that were inapplicable to us as a private company. These additional rules and regulations increased our legal, regulatory and financial compliance costs and will make some activities more time-consuming and costly.
The COVID-19 pandemic has caused a substantial disruption to the economy, as well as a heightened level of uncertainty about the scope and longevity of its impact. In response to the pandemic, we have implemented a multi-pronged approach to address the challenges caused by the effects of this pandemic. Our approach includes ensuring the safety of our employees and the communities that we serve and developing new and temporarily revised programs that are responsive to the needs of our loan and deposit customers. Although we entered this environment with a fundamentally sound loan portfolio and strong liquidity and capital positions, we deemed it prudent to provide additional loss absorbing loan reserves. As we continue to closely monitor COVID-19 developments, we remain focused on navigating these challenging conditions and ensuring the underlying strength and stability of our Company.
The safety and health of our employees are of paramount importance to us. Financial institutions have been designated as an essential component of our nation’s critical infrastructure, therefore, all of our branches have remained open during this challenging time. To limit our branch employees' exposure to risks related to COVID-19, we have temporarily modified our branch hours, expanded our phone support systems and enhanced branch safety protocols. A remote working arrangement has been implemented for the vast majority of our non-branch employees and approximately three-quarters of these employees, are successfully working from home. In recognition of the demands on families caused by "stay-at-home" orders and other precautionary measures, our employees are also being permitted to utilize a flexible work schedule to maintain our Company's productivity while fulfilling personal responsibilities. We have also provided other benefits such as wellness allowances for customer facing employees, the cash-out of a limited amount of accrued and unused vacation, as well as paid time off and counseling services
for employees requiring additional assistance. Our employees have successfully risen to the challenge of supporting our customers during this difficult time by providing quality service for both deposit and lending customers.
In late March 2020, the Company implemented a lending modification initiative to support customers financially impacted by the COVID-19 pandemic and unable to make their scheduled loan payments. The program provides borrowers the opportunity to modify their existing real estate loans by temporarily deferring payments for a specified period of time. In connection with the modifications, loan maturity dates are typically being extended for a commensurate period and deferred payments will be capitalized and reamortized into future monthly loan payments over the revised term of the loan. As a further accommodation to borrowers, all late charges are generally being waived for COVID-19 modifications. In conjunction with the passage of Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"), as well as the revised interagency guidance issued in April 2020, "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working With Customers Affected by the Coronavirus (Revised)", banks have been provided the option to temporarily suspend certain requirements under U.S. GAAP related to loan delinquencies and troubled debt restructurings ("TDRs") for a limited time to account for the effects of COVID-19. As a result, the Company has not recognized eligible COVID-19 loan modifications as TDRs. Additionally, loans qualifying for these modifications will not be required to be reported as delinquent, nonaccrual, impaired or criticized solely as a result of a COVID-19 loan modification. Modified loans under this program have generally been downgraded from a Pass risk rating to a Watch risk rating at the time of their respective modification. During the quarter ended December 31, 2020, loan grades were adjusted, as necessary, in connection with the Company's proactive reassessment of loans impacted by the pandemic. Loan risk ratings are an integral part of the quantitative calculation of our allowance for loan losses. Refer to Part II. Item 8. "Financial Statements" - "Note 4. Loans" for further details regarding loan risk ratings and the allowance for loan losses.
The following graphs detail completed COVID-19 loan hardship applications received as of December 31, 2020:
(1) Of the total 322 approved applications, 254 loans were modified and remain outstanding as of December 31, 2020, while 30 loans were modified and subsequently paid off. The remaining 38 applications were approved for modification but not accepted by the respective borrower.
The following table details completed COVID-19 loan hardship modifications as of December 31, 2020:
Total Loans Modified (1)
|(Dollars in thousands)||# of Loans||Current |
|% of Loan Portfolio Segment||Weighted Avg. LTV|
Weighted Avg. DSC(2)
Weighted Avg. DTI(2)
|Multifamily residential||99 ||$||176,787 ||4.3 ||%||60.1 ||%||1.26 ||N/A|
|Single family residential||135 ||145,642 ||8.6 ||%||68.9 ||%||N/A||39.6 ||%|
|Commercial real estate||20 ||53,576 ||26.5 ||%||57.4 ||%||1.31 ||N/A|
|Total||254 ||$||376,005 ||6.3 ||%||63.1 ||%||1.27 ||39.6 ||%|
(1) As of December 31, 2020, 25 single family loans totaling $33.4 million and five multifamily loans totaling $9.7 million have paid off subsequent to their modification and are excluded from the table above.
(2) Weighted average debt service coverage ("DSC") and debt-to-income ("DTI") are pre-COVID-19 measures.
The following table details modified loans in the population above which the borrower has returned, or expressed an intent to return, to monthly payments as of December 31, 2020:
Loans Returned/Returning to Payment Status (1)
|(Dollars in thousands)||# of Loans||Current |
|% of Total Modified Loans|
|Multifamily residential||99 ||$||176,787 ||100.0 ||%|
|Single family residential||134 ||144,531 ||99.2 ||%|
|Commercial real estate||20 ||53,576 ||100.0 ||%|
|Total||253 ||$||374,894 ||99.7 ||%|
(1) Loans which the borrower has confirmed payments will resume at the end of the modification period are included within Loans Returned/Returning to Payment Status. As of December 31, 2020, 250 loans totaling $372.4 million, have returned to scheduled payments. Two loans totaling $770 thousand are scheduled to resume payments in January 2021. The remaining loan, totaling $1.7 million, initially resumed making payments but has subsequently returned to delinquent status as of December 31, 2020.
The following table details the remaining modified loan as of December 31, 2020:
Remaining Modified Loan (1)
|(Dollars in thousands)||# of Loans||Current |
|% of Loan Portfolio Segment||Weighted Avg. LTV|
Weighted Avg. DTI(2)
|Single family residential||1 ||$||1,111 ||0.1 ||%||61.7 ||%||46.5 ||%|
(1) The loan reported as Remaining Modified Loan had not yet indicated if it would be able to resume payments as scheduled as of December 31, 2020.
(2) Weighted average DTI is a pre-COVID-19 measure.
The Company continues to originate loans for single family and multifamily borrowers desiring to refinance loans or execute real estate purchase transactions. As a result of the pandemic, however, the Company has temporarily tightened certain of its credit underwriting guidelines. While we continue to monitor the changing environment and the impacts of COVID-19 on employment and real estate values, at this time we remain committed to providing lending services. The Company did not participate in the Small Business Administration's Payment Protection Program.
To address depositors needs during the pandemic, we have kept all of our branches open, and have also increased ATM withdrawal limits with no consumer fees to ensure customer access to liquidity and promote their safety. Furthermore, we have implemented the waiver of certain early withdrawal penalties and overdraft fees related to deposit accounts, although very few fee concessions were requested. In addition, we have enhanced our customer communications via mailings and website postings to inform them of telephonic, online and mobile options for transacting business, as well as the need to have a greater awareness of perpetrated scams and fraudulent schemes related to COVID-19. As of December 31, 2020 compared to December 31, 2019, retail deposits have increased $395.6 million, while wholesale deposits decreased $366.0 million. The increase in retail deposits has
been primarily generated by our network of branches, while the decline in wholesale deposits was a purposeful decision by the Company to reduce excess, low yielding cash and cash equivalents from the consolidated statements of financial condition.
Allowance for Loan Losses
At December 31, 2020, 100% of our loan portfolio was secured by real estate collateral and 96.3% of our loan balances financed single family or multifamily residential housing having a weighted average loan-to-value of 58.7%. The Company has limited exposure to nonresidential commercial loans and little to no exposure to the industries most impacted by the pandemic such as travel, hospitality and entertainment. The following table shows the loan portfolio composition, with more granular emphasis on nonresidential commercial real estate, as of December 31, 2020:
|(Dollars in thousands)||# of Loans||Balance||% of Total Loans|
Weighted Average LTV (1)
|Multifamily residential||2,578 ||$||4,100,831 ||67.7 ||%||56.6 ||%|
|Single family residential||1,832 ||1,723,953 ||28.5 ||%||63.9 ||%|
|Commercial real estate type:|
|Strip Retail||23 ||48,808 ||0.8 ||%||51.1 ||%|
|Mid Rise Office||7 ||39,222 ||0.6 ||%||65.0 ||%|
|Low Rise Office||13 ||25,791 ||0.4 ||%||55.4 ||%|
|Medical Office||7 ||20,426 ||0.3 ||%||62.3 ||%|
|Multi-Tenant Industrial||8 ||12,782 ||0.2 ||%||49.1 ||%|
|Anchored Retail||3 ||12,216 ||0.2 ||%||53.2 ||%|
|More than 50% commercial||11 ||10,848 ||0.2 ||%||47.2 ||%|
|Shopping Center||4 ||8,778 ||0.1 ||%||50.5 ||%|
|Unanchored Retail||7 ||8,495 ||0.1 ||%||44.4 ||%|
|Shadow Retail||4 ||6,978 ||0.1 ||%||59.6 ||%|
|Warehouse||4 ||3,082 ||0.1 ||%||41.3 ||%|
|Flex Industrial||2 ||2,488 ||0.0 ||%||64.1 ||%|
|Restaurant||2 ||1,527 ||0.0 ||%||34.0 ||%|
|Light Manufacturing||1 ||1,341 ||0.0 ||%||49.4 ||%|
|Other||1 ||89 ||0.0 ||%||16.9 ||%|
|Commercial Real Estate||97 ||202,871 ||3.4 ||%||55.1 ||%|
|Construction & Land Development||11 ||22,061 ||0.4 ||%||56.5 ||%|
|Non-mortgage Loans||1 ||100 ||0.0 ||%||NA|
|Total||4,519 ||$||6,049,816 ||100.0 ||%||58.6 ||%|
|(1) Construction and land development LTV is calculated based on an "as completed" property value.|
As a result of the COVID-19 pandemic, we increased both the qualitative and quantitative components of our allowance for loan losses. The qualitative component was increased to address the continued uncertainty surrounding the current economic environment, while the quantitative component was increased as a result of grade changes related to loans impacted by the pandemic, as discussed above. During the year ended December 31, 2020, we added $12.4 million to our reserve for these purposes. The following table shows the components attributed to the net increase in our allowance for loan losses during the year ended December 31, 2020:
|(Dollars in thousands)|
|Allowance for Loan Losses - as of 12/31/2019 ||$||36,001 |
|COVID-19 impact||12,449 |
|Decline in portfolio and other changes||(1,899)|
|Allowance for Loan Losses - as of 12/31/2020 ||$||46,214 |
Liquidity and Capital
As part of our response to COVID-19, we continue to closely monitor our liquidity and capital levels to ensure that we are properly prepared for the economic uncertainty caused by the pandemic. The Company's cash and cash
equivalents have increased by $81.4 million since December 31, 2019 primarily as a result of reduced loan origination volumes, elevated loan prepayments and increases in retail deposits. As of December 31, 2020, we maintained the following liquidity position:
|(Dollars in thousands)||As of 12/31/2020||% of Assets|
|Cash & Cash Equivalents||$||169,941 ||2.5 ||%|
|Unencumbered Liquid Securities||605,771 ||8.8 ||%|
Unutilized Brokered Deposit Capacity (1)
|739,649 ||10.7 ||%|
Unutilized FHLB Borrowing Capacity (2)(3)
|900,020 ||13.0 ||%|
Unutilized FRB Borrowing Capacity (2)
|178,593 ||2.6 ||%|
|Commercial Lines of Credit||50,000 ||0.7 ||%|
| Total Liquidity||$||2,643,974 ||38.3 ||%|
|(1) Capacity based on internal guidelines|
|(2) Capacity based on pledged loan collateral specific to the FHLB or FRB, as applicable|
(3) Availability to borrow from the FHLB is permitted up to 40% of the Bank's assets or $2.8 billion. At December 31, 2020, we had $806.7 million and $62.6 million in outstanding advances and letters of credit with the FHLB, respectively.
The Company’s capital levels continue to be significantly above the minimum levels required for regulatory capital purposes. At December 31, 2020, our Tier 1 Leverage, Common Equity Tier 1 Risk-Based, Tier 1 Risk-Based and Total Risk-Based Capital ratios were 9.5%, 15.8%, 17.4% and 18.6%, respectively. Refer to Part II. Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" - "Capital Adequacy" for further details regarding our capital levels at December 31, 2020. The following graphs depict the Company’s capital position in relation to current regulatory requirements including capital conservation buffers:
Results of Operations - Years ended December 31, 2020 and 2019
For the year ended December 31, 2020 our net income was $39.9 million as compared to $48.9 million for the year ended December 31, 2019. The decrease of $8.9 million, or 18.3%, was primarily attributable to a $11.6 million increase in noninterest expense, a $9.3 million increase in the provision for loan losses and a decrease of $2.2 million in noninterest income, partially offset by an increase of $10.2 million in net interest income and a decrease of $3.9 million in the provision for income taxes as compared to the prior year. Pre-tax, pre-provision net earnings decreased by $3.5 million, or 5.0%, for the year ended December 31, 2020 as compared to the prior year. Excluding the impact of a $10.4 million non-recurring cost incurred in connection with the prepayment of $150.0 million of long-term fixed rate FHLB borrowings in December 2020, net income would have been $47.3 million for the year ended December 31, 2020.
Net Interest Income
Net interest income totaled $138.6 million for the year ended December 31, 2020, an increase of $10.2 million, compared to the prior year. The increase in net interest income was primarily impacted by a 63 basis point decline in the cost of interest-bearing deposits. Net interest income was further enhanced by a decrease in the average balance and cost of FHLB advances of $91.1 million and 11 basis points, respectively. These items were partially offset by $12.9 million increase in the cost of our interest rate swaps as compared to the prior year, as well as the prepayment of higher yielding loans, which are being replaced by loans at lower current interest rates. Net interest income was also impacted by an 82 basis point decline in the yield on our investment securities. The decline in our investment yield was generally caused by variable rate securities repricing to lower current interest rates, as well as the accelerated prepayment of securities backed by mortgages.
Net interest margin for the year ended December 31, 2020 was 1.97%, compared to 1.84% for the prior year. The increase in our margin was primarily related to the decline in the cost of our interest-bearing deposits, partially offset by the decline in the yields of our loan and investment portfolios, as discussed above. Over the year, the yield on our interest-earning assets decreased by 39 basis points, while the cost of our interest-bearing liabilities decreased by 56 basis points. Our net interest spread for the year ended December 31, 2020 was 1.83%, increasing by 17 basis points as compared to last year.
Average balance sheet, interest and yield/rate analysis. The following table presents average balance sheet information, interest income, interest expense and the corresponding average yield earned and rates paid for the years ended December 31, 2020, 2019 and 2018. The average balances are daily averages.
|For the Years Ended December 31,|
|(Dollars in thousands)||Average Balance||Interest Inc/Exp||Yield/Rate||Average Balance||Interest Inc/Exp||Yield/Rate||Average Balance||Interest Inc/Exp||Yield/Rate|
|Multifamily residential||$||4,063,607 ||$||155,104 ||3.82 ||%||$||3,870,897 ||$||162,328 ||4.19 ||%||$||3,321,691 ||$||127,950 ||3.85 ||%|
|Single family residential||1,907,940 ||65,030 ||3.41 ||%||2,139,517 ||76,766 ||3.59 ||%||2,149,154 ||75,906 ||3.53 ||%|
|Commercial real estate||206,639 ||9,530 ||4.61 ||%||196,903 ||9,353 ||4.75 ||%||147,494 ||6,935 ||4.70 ||%|
|Construction, land and NM||20,199 ||1,332 ||6.59 ||%||15,907 ||1,083 ||6.81 ||%||27,013 ||1,044 ||3.86 ||%|
|Total Loans (1)||6,198,385 ||230,996 ||3.73 ||%||6,223,224 ||249,530 ||4.01 ||%||5,645,352 ||211,835 ||3.75 ||%|
|Investment securities||647,174 ||9,856 ||1.52 ||%||661,574 ||15,461 ||2.34 ||%||584,898 ||12,430 ||2.13 ||%|
|Cash, cash equivalents and restricted cash||185,246 ||538 ||0.29 ||%||105,042 ||2,151 ||2.05 ||%||98,524 ||1,792 ||1.82 ||%|
|Total interest-earning assets||7,030,805 ||241,390 ||3.43 ||%||6,989,840 ||267,142 ||3.82 ||%||6,328,774 ||226,057 ||3.57 ||%|
|Noninterest-earning assets (2)||61,602 ||76,707 ||77,157 |
|Total assets||$||7,092,407 ||$||7,066,547 ||$||6,405,931 |
|Transaction accounts||$||309,601 ||1,789 ||0.57 ||%||$||210,743 ||2,686 ||1.26 ||%||$||176,725 ||1,541 ||0.86 ||%|
|Money market demand accounts||1,521,163 ||13,949 ||0.90 ||%||1,402,608 ||18,181 ||1.28 ||%||1,464,952 ||14,954 ||1.01 ||%|
|Time deposits||3,390,992 ||57,593 ||1.67 ||%||3,538,223 ||84,225 ||2.35 ||%||2,863,852 ||52,617 ||1.81 ||%|
| Total deposits||5,221,756 ||73,331 ||1.38 ||%||5,151,574 ||105,092 ||2.01 ||%||4,505,529 ||69,112 ||1.51 ||%|
|FHLB advances||965,490 ||21,761 ||2.25 ||%||1,056,557 ||24,896 ||2.36 ||%||1,069,216 ||23,285 ||2.18 ||%|
|Junior subordinated debentures||61,857 ||1,373 ||2.22 ||%||61,857 ||2,447 ||3.96 ||%||61,857 ||2,266 ||3.66 ||%|
|Senior debt||94,473 ||6,302 ||6.67 ||%||94,350 ||6,300 ||6.68 ||%||94,223 ||6,307 ||6.69 ||%|
|Total interest-bearing liabilities ||6,343,576 ||102,767 ||1.60 ||%||6,364,338 ||138,735 ||2.16 ||%||5,730,825 ||100,970 ||1.74 ||%|
|Noninterest-bearing deposit accounts||69,208 ||41,821 ||51,152 |
|Noninterest-bearing liabilities||68,853 ||60,814 ||57,679 |
|Total liabilities||6,481,637 ||6,466,973 ||5,839,656 |
|Total stockholders' equity||610,770 ||599,574 ||566,275 |
|Total liabilities and stockholders' equity||$||7,092,407 ||$||7,066,547 ||$||6,405,931 |
|Net interest spread (3)||1.83 ||%||1.66 ||%||1.83 ||%|
|Net interest income/margin (4)||$||138,623 ||1.97 ||%||$||128,407 ||1.84 ||%||$||125,087 ||1.98 ||%|
(1) Non-accrual loans are included in total loan balances. No adjustment has been made for these loans in the calculation of yields. Interest income on loans includes amortization of deferred loan costs, net of deferred loan fees. Net deferred loan cost amortization totaled $16.2 million, $14.6 million and $10.2 million for the years ended December 31, 2020, 2019 and 2018, respectively.
(2) Noninterest-earning assets includes the allowance for loan losses.
(3) Net interest spread is the average yield on total interest-earning assets minus the average rate on total interest-bearing liabilities.
(4) Net interest margin is net interest income divided by total average interest-earning assets.
Interest rates and operating interest differential. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities during the periods indicated. The effect of changes in volume is determined by multiplying the change in volume by the prior period’s average rate. The effect of rate changes is calculated by multiplying the change in average rate by the prior period’s volume. The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the changes in each.
|For the Years Ended December 31, 2020 vs 2019|
|Variance Due To|
|(Dollars in thousands)||Volume||Yield/Rate||Total |
|Multifamily residential||$||7,723 ||$||(14,947)||$||(7,224)|
|Single family residential||(8,021)||(3,715)||(11,736)|
|Commercial real estate||456 ||(279)||177 |
|Construction, land and NM||285 ||(36)||249 |
|Total Loans||443 ||(18,977)||(18,534)|
|Cash, cash equivalents and restricted cash||981 ||(2,594)||(1,613)|
|Total interest-earning assets||1,096 ||(26,848)||(25,752)|
|Transaction accounts||928 ||(1,825)||(897)|