UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the Year Ended December 31 , 2022
OR
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) | |||||||
(Address of principal executive offices) | (Zip Code) | |||||||
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 | ||||||||||||
Securities Registered Pursuant to Section 12(g) of the Act:
None
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 | o | ☒ | ||||||||||||
| Non-accelerated filer | o | 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. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
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, 2022, 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 $132.2 million based on the closing price per share of common stock of $13.05 on June 30, 2022.
As of February 17, 2023, there were 51,022,485 shares of the registrant’s common stock, no par value, outstanding.
Table of Contents
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| Part I | ||||||||
| Part II | ||||||||
| Part III | ||||||||
| Part IV | ||||||||
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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 document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including our current views with respect to, among other things, future events and our results of operations, financial condition, financial performance, plans and/or strategies. These forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and 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. These forward-looking statements 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 and involve a number of risks and uncertainties. Accordingly, we caution you that any such forward-looking statement is not a guarantee of future performance and that actual results may prove to be materially different from the results expressed or implied by the forward-looking statements due to a number of factors, including without limitation:
•interest rate, liquidity, economic, market, credit, operational and inflation risks associated with our business, including the speed and predictability of changes in these risks;
•our ability to retain deposits and attract new deposits and loans and the composition and terms of such deposits and loans;
•business and economic conditions generally and in the financial services industry, nationally and within our current and future geographic markets, including the tight labor market, ineffective management of the U.S. Federal budget or debt or turbulence or uncertainty in domestic or foreign financial markets;
•any failure to adequately manage the transition from LIBOR as a reference rate;
•changes in the level of our nonperforming assets and charge-offs;
•the adequacy of our allowance for loan losses;
•our management of risks inherent in our real estate loan portfolio, including the seasoning of the portfolio, the level of non-conforming loans, the number of large borrowers, and the risk of a prolonged downturn in the real estate market;
•significant market concentrations in California and Washington;
•the occurrence of significant natural or man-made disasters (including fires, earthquakes and terrorist acts), severe weather events, health crises and other catastrophic events;
•climate change, including any enhanced regulatory, compliance, credit and reputational risks and costs;
•political instability or the effects of war or other conflicts, including, but not limited to, the current conflict between Russia and Ukraine;
•the announced merger with Washington Federal, Inc., including delays in the consummation of the merger or litigation or other conditions that may cause the parties to abandon the merger or make the merger more expensive or less beneficial;
•the impact that the announced merger may have on our ability to attract and retain customers and key personnel, the value of our shares, our expenses, and/or our ability to conduct our business in the ordinary course and execute on our strategies;
•the performance of our third-party vendors;
•fraud, financial crimes and fund transfer errors;
•failures, interruptions, cybersecurity incidents and data breaches involving our data, technology and systems and those of our customers and third-party providers;
•rapid technological changes in the financial services industry;
•any inadequacy in our risk management framework or use of data and/or models;
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•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;
•our involvement from time to time in legal proceedings and examinations and remedial actions by regulators;
•increased competition in the financial services industry; and
•changes in our reputation.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included this Annual Report on Form 10-K ("Annual Report"), including under the caption “Risk Factors” in Item 1A of Part I and other reports we file with the Securities and Exchange Commission ("SEC"). You should not place undue reliance on any of these 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, except as required by law.
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PART I.
Item 1. Business
General
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 executive offices in Santa Rosa and 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 in the western U.S. and has developed expertise in multifamily residential, jumbo nonconforming single family residential and commercial real estate lending.
Recent Developments
On November 13, 2022, the Company entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) with Washington Federal, Inc. (“WAFD”), pursuant to which the Company will merge with and into WAFD (the “Corporate Merger”), with WAFD surviving the Corporate Merger. Promptly following the Corporate Merger, the Company’s wholly-owned bank subsidiary, Luther Burbank Savings, will be merged with and into Washington Federal Bank, dba WaFd Bank, the wholly-owned bank subsidiary of WAFD (“WAFD Bank”), with WAFD Bank as the surviving institution. In accordance with the terms of the Merger Agreement, the Company’s shareholders will receive 0.3353 shares of WAFD common stock for each share of the Company's issued and outstanding common stock. Closing of the transaction, which is expected to occur in 2023, is contingent upon shareholder approval and receipt of all necessary regulatory approvals, along with the satisfaction of other customary closing conditions.
Business Strategies
We intend to continue executing our strategic plan by focusing on the following key objectives:
•Continued organic lending growth in our strategic markets. Our primary focus is to grow our customer 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 major metropolitan markets in the western U.S., including our recent expansion to Arizona, Colorado and Utah. 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 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 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 new markets.
•Deepen customer 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 on individual savings deposits from high net worth, primarily self-employed individuals, entrepreneurs and professionals, and we did not emphasize transactional accounts. 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
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provide the level of customer service for which we are known to our consumer depositors. 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 and nonprofits; and
•increasing our digital market presence including the use of social media.
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. 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.
Market Area
Our operations are primarily 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 several loan production offices located throughout California. 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 markets, and other major metropolitan markets that share key demographic characteristics with our markets, including our recent expansion into Arizona, Colorado and Utah.
Competition
We operate in a highly competitive industry and in highly competitive markets throughout the western United States. 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
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operations and mid-sized regional banking institutions, while in the single family lending market, we face competition from a wide array of institutions. For both lending and deposit customers, we compete with other community banks, 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 the U.S. Department of Treasury, 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 the U.S. Department of Treasury and 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 Fremont Bank, WaFd Bank, Florida Capital 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.
Lending Activities
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;
•Clackamas, Multnomah and Washington counties in Oregon:
•Maricopa county in Arizona;
•Adams, Arapahoe, Boulder, Broomfield, Denver, Douglas, El Paso and Jefferson counties in Colorado; and
•Davis, Provo, Salt Lake, Utah and Weber counties in Utah.
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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, Washington and Oregon 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 nonresidential commercial property 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 originated on a retail basis, through the marketing efforts of our bankers and loan production offices, and 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 and, to a lesser extent, 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.
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•Grow and Daisy.
We also offer a portfolio 30-year fixed rate first mortgage and a forgivable second mortgage 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 limit 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.
Investment Activities
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"), the Federal Farm Credit Banks Funding Corporation and the U.S. Department of Education (guarantee of Sallie Mae securities). Securities issued by the SBA, NCUA and GNMA are backed by the full faith and credit of the federal government.
Funding Activities
Deposits.
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 ATM access worldwide on the MoneyPass and Allpoint networks. 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 continue 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 worldwide 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.
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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 and nonprofits. 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. Our reliance on brokered deposits increased during 2022 given the rapid rise in interest rates and the competitive environment for generating retail deposits.
Borrowings.
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 deposits at acceptable rates and in comparable amounts.
Risk Management
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
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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 this 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 website, 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 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.
Human Capital
As of December 31, 2022 and 2021, we had 256 and 281 employees, respectively, nearly all of whom are full-time. As a financial institution, approximately 27% of our employees are employed at our branch and loan production offices. The remaining portion of our employees generally work from our administrative offices in 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 your financial future with a superior human-centered experience - whether you are a customer, employee, or shareholder." 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 2022 and 2021, 34% and 44%, respectively, of our new hires were from an employee referral. During the years ended December 31, 2022 and 2021, our employee voluntary turnover ratios were 23% and 16%, respectively. As of December 31, 2022 and 2021, 59% and 52%, respectively, 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. During the years ended December 31, 2022 and 2021, individuals from underrepresented groups filled 65% and 61%, respectively, of the Company's promotions and hirings. As of December 31, 2022, women represented 67% of our workforce and 43% of our executive management team. As of December 31, 2022, the population of our workforce, based on employee self-reported information or Human Resources’ observation, was as follows:
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(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.
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/or 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 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."
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.
Historically, we have been, and, as of December 31, 2022, we remain, a liability-sensitive institution, which means 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. This was the case in 2022, when the Board of Governors of the Federal Reserve System (“Federal Reserve”), significantly increased interest rates and the benchmark rate at an unprecedented pace, and as a result, our weighted average cost of interest-bearing liabilities increased from 0.73% during the quarter ended December 31, 2021 to 2.15% during the quarter ended December 31, 2022, while at the same time our weighted average yield on interest-earning assets only increased from 3.23% during the quarter ended December 31, 2021 to 4.00% during the quarter ended December 31, 2022, resulting in a decrease in our net interest margin from 2.57% to 2.01% for the quarters ended December 31, 2021 and 2022, respectively. Additional repricing in our interest-bearing liabilities as a result of past interest rate increases and any further Federal Reserve increases in interest rates and the benchmark rate may negatively affect our net interest income.
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 and as described above, the Federal Reserve. Changes in monetary policy, including changes in interest rates, influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes also 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. 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,
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unexpected, prolonged or rapid change in market interest rates could have a material adverse impact on our business, financial condition and results of operations. 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.
An increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay 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.
Liquidity Risk
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, satisfy customer deposit withdrawals at maturity and on demand, make payments on our debt obligations as they come due and satisfy other cash commitments under both normal operating conditions and other challenging or unpredictable circumstances, including events causing industry or general financial market stress. To fund our operations, we rely on customer deposits, advances from the FHLB, which is one of eleven banks in the Federal Home Loan Bank system ("FHLB System"), brokered deposits, occasional loan sales and, to a lesser extent, advances from the FRB.
Liquidity risk, which includes our ability to access liquidity sources such as customer deposits, advances from the FHLB and FRB, and brokered deposits, can increase due to a number of factors, including: adverse changes in our financial condition or performance or in our CRA rating; a decrease in the level of our deposit activity, including as a result of customers moving funds into higher yielding assets or changes in the liquidity needs of our depositors; adverse regulatory actions against us; an over-reliance on a particular source of funding; the financial condition of the FRB, FHLB and the FHLB System; and market-wide phenomena such as market dislocation and major disasters.
As of December 31, 2022, we estimated that $1.3 billion of our deposits exceeded the insurance limits established by the FDIC. None of our deposits are governmental deposits secured by collateral. Our inability to retain and raise funds, or inability to retain and raise funds on competitive terms, through deposits, FHLB and FRB borrowings, the sale of loans, and other sources could have a substantial negative effect on our 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. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity, including as a result of the rapidly rising interest rates in 2022 and any future increase in interest rates, could impair our ability to fund operations and meet our obligations as they become due (including our senior notes due in September 2024 with a balance of $95 million at December 31, 2022); could have a material adverse effect on our business, financial condition and results of operations; and could result in the closure of the Bank.
We may not be able to retain or grow our core deposit base, which could adversely impact our funding costs. 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 financial condition and financial performance largely depend on our ability to maintain our deposit base in a profitable manner. Customer deposits are subject to potentially dramatic fluctuations in availability or price due to various factors, most of which are outside of our control, such as increasing competitive pressures, 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 or other terms necessary to maintain current customer deposits or attract additional deposits.
Our deposit customers tend to be more interest-rate sensitive than customers at some competitor banks, which means our deposit customers may be more likely to move funds into higher-yielding investment alternatives than deposit customers at some of our competitor banks. The recent rapidly rising interest rate environment and resulting
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competition for deposits has made it challenging for us to attract and retain certain deposit customers and maintain our profitability, which in turn has resulted in lower margins. Additional repricing in our interest-bearing liabilities as a result of past interest rate increases as well as future interest rate increases and/or a prolonged high interest rate environment could result in decreased loan originations and margins, which could have a material adverse effect on our business, financial condition and results of operations.
Economic and Market Conditions Risk
Our business and operations may be materially adversely affected by weak or uncertain 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, economic and political conditions could affect the stability of 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 and uncertain economic conditions caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences including, but not limited to, the conflict in Ukraine and related developments, the COVID-19 pandemic or other pandemics, unemployment, changes in securities markets, declines in home values, ineffective management of the U.S. Federal budget or debt, a tightening credit environment or other factors, and U.S. and foreign government policy responses to such conditions including, but not limited to, sanctions, could have a material adverse effect on our business, financial condition and results of operations. For example, the rapid and significant increase in interest rates during 2022 combined with historically below average real estate inventory levels have decreased demand for the Company’s real estate loan products. Real estate refinance activity and loan payoffs are strongly correlated with changes in mortgage interest rates. Rising mortgage rates during the last year resulted in fewer loan payoffs and had an adverse impact on the Company’s business, which conditions are expected to continue for so long as mortgage rates continue to rise or if they subsequently remain high relative to the interest rates of outstanding mortgages.
The replacement of the LIBOR benchmark interest rate may adversely affect our results of operations. We have financial instruments that are priced based on variable interest rates tied to LIBOR. On July 27, 2017, the United Kingdom’s Financial Conduct Authority (“FCA”) announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. On November 30, 2020, to facilitate an orderly LIBOR transition, the Office of the Comptroller of the Currency ("OCC"), the Federal Deposit Insurance Corporation ("FDIC"), and the Federal Reserve jointly announced that entering into new contacts using LIBOR as a reference rate after December 31, 2021 would create a safety and soundness risk. On March 5, 2021, the FCA announced that all LIBOR settings will either cease to be provided by any administrator or no longer be representative immediately after December 31, 2021, in the case of 1-week and 2-month U.S. dollar LIBOR, and immediately after June 30, 2023, in the case of the remaining U.S. dollar LIBOR settings. In the United States, efforts to identify a set of alternative U.S. dollar reference interest rates are ongoing, and the Alternative Reference Rate Committee (“ARRC”) has recommended the use of the Secured Overnight Financing Rate ("SOFR"). SOFR is different from LIBOR in that it is a secured rate rather than an unsecured rate. This difference could lead to a greater disconnect between our ability to make loans using SOFR and our costs to raise funds for SOFR as compared to LIBOR. For cash products and loans, the ARRC has recommended Term SOFR with a credit spread, which is a forward-looking SOFR based on SOFR futures and may in part reduce differences between SOFR and LIBOR.
As of December 31, 2022, we had $529.2 million of loans, $245.3 million of investments, $61.9 million of junior subordinated deferrable interest debentures and $15.9 million of other assets that were indexed to LIBOR. There are also operational issues which may create a delay in the transition to SOFR or other substitute indices, leading to uncertainty across the industry. The implementation of a substitute index or indices, or the use of a fixed interest rate, for the calculation of interest rates under our financial instruments may cause significant expenses in effecting the transition, may result in reduced loan balances if our borrowers do not accept the substitute index or indices, may result in increased expenses if holders of the junior subordinated deferrable interest debentures or other counterparties to our financial instruments do not accept a substitute index or indices, or attempt to establish a fixed interest rate, and may result in disputes or litigation with customers, trustees or noteholders over the appropriateness or comparability to LIBOR of the substitute index or indices or other interest rate calculations, which could have an adverse effect on our results of operations. These consequences cannot be entirely predicted and could have an adverse impact on the market value for or value of LIBOR-linked securities, loans, and other financial obligations or extensions of credit held by or due to us.
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Credit Risk
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, tenant vacancy rates, rent control regulations, eviction moratoriums and limitations, and economic conditions that may have a disparate impact on some tenants of properties within this portfolio, many of which are low or moderate income tenants or small businesses.
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, employment or any other conditions affecting customers and the quality of the loan portfolio. Many of our loans are made to individuals or small businesses that are less able to withstand competitive, economic and financial pressures than larger businesses. 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. No matter how effectively we measure and limit such credit risk, we may still experience certain negative consequences during economic downturns, especially when such downturns are either severe or prolonged or when unemployment is high. 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 other 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, 2022, our multifamily residential loans totaled $4.5 billion, or 64.7%, of our loan portfolio, and our other CRE loans totaled $172.3 million, or 2.5% of our loan portfolio. Nonperforming multifamily residential loans were $3.5 million at December 31, 2022. There were no nonperforming other CRE loans at December 31, 2022. Multifamily residential and other CRE loans that involve large loan balances concentrated with a single borrower or groups of related borrowers may carry significant credit risk. The payment on multifamily residential and other CRE 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 or limitations on evictions for non-payment, personal and corporate tax reform, pass-through rules, immigration and fiscal and economic policy. The collateral securing these loans, particularly CRE loans, may not be liquidated as easily as single family residential (“SFR”) real estate during economic downturns or other unfavorable conditions, 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 other CRE loan portfolios could require us to increase our allowance for loan losses, which would reduce our profitability and could materially adversely affect 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. These estimates of loan losses are necessarily subjective and their accuracy depends on the outcome of future events. Inaccurate
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management assumptions, deterioration of economic conditions affecting borrowers, declines in real estate values, 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 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.
Further impacting the sufficiency of our current allowance for loan losses is the implementation of the Current Expected Credit Losses ("CECL") allowance methodology, which we adopted on January 1, 2023. The CECL methodology depends on future economic forecasts, assumptions and models that are inherently uncertain and may prove to be inaccurate and could result in increases in, and add volatility to, our allowance for loan losses and future provisions for loan losses.
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, 2022, approximately $4.5 billion, or 63.9% of the loans in our loan portfolio were originated since January 1, 2019, excluding 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. Therefore, since a large portion of our loan portfolio is relatively new, 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. Our credit underwriting process, our ongoing credit review processes, and our management of our loan portfolio may not be adequate to mitigate these risks. 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 SFR mortgage loans we have originated consist of 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 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, 2022, we had 28 borrowing relationships in excess of $20 million which accounted for approximately 15.6% of our loan portfolio. These borrower relationships had an average of 12 loans outstanding per relationship. 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.
Risks Related to the Merger
The consummation of the recently-announced merger with WAFD is contingent upon the satisfaction of a number of conditions, including shareholder and regulatory approvals, that may be outside of our control and that we may be unable to satisfy or obtain or which may delay the consummation of the merger or result in the imposition of conditions that could cause the parties to abandon the merger. As noted in Note 1 in Part II - Item 8. "Notes to Consolidated Financial Statements”, on November 13, 2022, the Company and WAFD entered into the Merger Agreement, pursuant to which, and subject to the terms and conditions of the Merger Agreement, the Company will merge with and into WAFD, with WAFD as the surviving institution, promptly followed by the merger of Luther Burbank Savings with and into Washington Federal Bank, dba WaFd Bank, with WAFD Bank as the surviving institution (collectively, the “Merger”).
Before the transactions contemplated in the Merger Agreement can be completed, approvals must be obtained from regulatory authorities, shareholders and other customary closing conditions must have been satisfied or waived. The required regulatory approvals may require changes to the terms of the transactions contemplated by the Merger Agreement. There can be no assurance that our or WAFD’s regulators will not impose any additional conditions, limitations, obligations or restrictions on the parties, or that they will not have the effect of delaying or
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preventing the completion of the Merger, imposing additional material costs on or materially limiting the revenues of the surviving entity following the Merger or otherwise reducing the anticipated benefits of the Merger.
Uncertainties about the effect of the Merger may impair our ability to attract, retain and motivate key personnel until the Merger is consummated and for a period of time thereafter, and could cause customers and others that deal with us to seek to change their existing business relationships with us. It is not unusual for competitors to use mergers as an opportunity to target the merging parties’ customers and to hire certain of their employees. Employee retention may be particularly challenging during the pendency of the Merger, as employees may experience uncertainty about their roles with the surviving entity following the Merger.
The Merger Agreement contains provisions that restrict our ability to, among other things, initiate, solicit, knowingly encourage or knowingly facilitate, inquiries or proposals with respect to, or, subject to certain exceptions generally related to our Board of Directors’ exercise of fiduciary duties, engage in any negotiations concerning, or provide any confidential information relating to, any alternative acquisition proposals. These provisions, which include payment of a termination fee of $26.17 million (the “Termination Fee”) payable to WAFD, which, under certain circumstances, may discourage any potential competing acquirer having an interest in acquiring us from proposing a transaction, or may result in the offer of a lower per share price to acquire us than might otherwise have been proposed.
The value to be recognized by our shareholders from the Merger is subject to material uncertainties. The Merger Agreement provides that upon the closing of the Merger our shareholders will receive per share of common stock of Luther Burbank, 0.3353 shares of common stock, par value $1.00 per share, of WAFD and cash in lieu of fractional shares of WAFD common stock. The exchange ratio for the conversion of our common stock into common stock of WAFD (“WAFD Common Stock”) was set based upon information available to the boards of directors and financial advisors of each company at the time the Merger Agreement was entered into. The market price of our common stock and of WAFD Common Stock fluctuates constantly in response to a variety of factors that are inherently unpredictable and outside of our control, including changes in our and WAFD’s business, operations and prospects, and regulatory considerations, the historical and anticipated future financial results of our respective banking operations and general market and economic developments affecting the United States and international businesses and financial markets. The substantial differences between our business and the business of WAFD will subject our shareholders to new and different risks than those with which they are familiar with our business. A period of months may transpire between the date that our shareholders are asked to approve the Merger and the earliest date the Merger can be closed, during which time the price of the Company’s common stock and WAFD Common Stock will continue to fluctuate and WAFD’s adjusted shareholders’ equity may continue to fluctuate. As a result, at the time that our shareholders must decide whether to approve the Merger Agreement, they may not necessarily know the precise value of the merger consideration they will receive, which could be materially different than the value of the merger consideration at the closing of the Merger.
Failure to complete the proposed Merger could negatively impact our business, financial results and stock price. If the proposed Merger is not completed for any reason, our ongoing business may be adversely affected and, without realizing any of the benefits of having completed the Merger, we would be subject to a number of related risks, including the following:
•We may be required, under certain circumstances, to pay WAFD the termination fee under the Merger Agreement, which may adversely affect our financial performance and the price of our common stock;
•We will have incurred substantial expenses and will be required to pay significant costs relating to the Merger, whether or not it is completed, such as legal, accounting, due diligence, financial advisor and printing fees;
•The Merger Agreement places certain restrictions on the conduct of our business prior to completion of the Merger, which may adversely affect our ability to execute certain of our business strategies and cause certain other projects to be delayed or abandoned;
•Matters relating to the Merger require substantial commitments of time and resources by our management team that could have been devoted to the pursuit of other opportunities beneficial to us as an independent company; and
•We may be subject to negative reactions from the financial markets and from our customers and employees that could materially affect our business, financial results and stock price; and the market price of our common stock could decline to the extent that current market prices of our common stock reflect a market assumption that the Merger will be completed.
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Litigation could prevent or delay the closing of the proposed Merger or otherwise negatively impact our business and operations. We may be subject to legal proceedings related to the agreed terms of the proposed Merger, the manner in which the Merger was considered and approved by our board of directors or any failure to complete the Merger or perform our obligations under the Merger Agreement. Such litigation, regardless of the merits, could delay or block the consummation of the Merger, have an adverse effect on our financial condition and impose material costs on us or the surviving entity. One of the conditions to the closing of the Merger is that no regulation, judgment, decree, injunction or other order of a governmental authority (including any federal, state or local court or administrative or regulatory agency) which prohibits the consummation of the Merger be in effect. If any plaintiff were successful in obtaining an injunction prohibiting us or WAFD from completing the Merger on the agreed upon terms, then such injunction may prevent the Merger from becoming effective or from becoming effective within the expected timeframe.
Geographic Concentration and Climate 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, 2022, approximately 88% of the loans in our portfolio measured by dollar amount were secured by collateral located in California and 9% of the loans in our portfolio measured by dollar amount were secured by collateral located in Washington. In addition, 61% 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, including the strength of the rental and residential purchase markets, which we cannot predict with certainty. As a result, our operations and profitability may be more adversely affected by a local economic downturn in these areas 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, severe weather events, health crises or other catastrophic events. 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-related disasters, including fires, mudslides, floods, droughts and other disasters. Our other locations and places where we do business are also subject to natural disasters and severe weather events. The policies and procedures we have implemented to monitor and mitigate these risks, specifically flood and wildfire risk, in our loan portfolio may prove inadequate. Additionally, acts of terrorism, war, civil unrest, violence, or other man-made disasters, as well as energy shortages, water shortages and health crises, such as the COVID-19 pandemic, and governmental responses to those events have caused and could cause disruptions to our business or to the economies where we do business. The occurrence of these disasters and other events, and governmental responses thereto, could destroy, or cause a decline in the value of, mortgaged properties that serve as our collateral; increase the risk of delinquencies, defaults, foreclosures and losses on our loans; damage our banking facilities and offices; negatively impact economic conditions in our markets; result in a decline in loan demand and loan originations; result in drawdowns of and/or fewer deposits by customers; and negatively impact the implementation of our strategy.
We have implemented a disaster recovery and business continuity plan that is designed to allow us to move critical functions to a backup data center in the event of a catastrophe. Although this program is tested periodically, it may not be effective in an actual disaster. Regardless of the effectiveness of our disaster recovery and business continuity plan, the occurrence of any natural or man-made disaster, severe weather conditions, health crises or other events could have a material adverse effect on our business, financial condition and results of operations.
Climate change could have a material negative impact on the Company and customers. The Company’s business, as well as the operations and activities of our customers, could be negatively impacted by climate change. Climate change presents both immediate and long-term risks to the Company and its customers, and these risks are expected to increase over time. Climate change presents multi-faceted risks, including: operational risk from the physical effects of climate events on the Company and its customers’ facilities and other assets; credit risk from borrowers with significant exposure to climate risk; transition risks associated with the transition to a less carbon-dependent economy; and reputational risk from stakeholder concerns about our practices related to climate change and the Company’s carbon footprint.
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Federal and state banking regulators and supervisory authorities, investors, and other stakeholders have increasingly viewed financial institutions as important in helping to address the risks related to climate change both directly and with respect to their customers, which may result in financial institutions coming under increased pressure regarding the disclosure and management of their climate risks and related lending and investment activities. Given that climate change could impose systemic risks upon the financial sector, either via disruptions in economic activity resulting from the physical impacts of climate change or changes in policies as the economy transitions to a less carbon-intensive environment, the Company may face regulatory risk of increasing focus on the Company’s resilience to climate-related risks, including in the context of stress testing for various climate stress scenarios. Ongoing legislative or regulatory uncertainties and changes regarding climate risk management and practices may result in higher regulatory, compliance, credit, and reputational risks and costs.
Although we have made efforts to enhance our governance of climate change-related risks and integrate climate considerations into our risk governance framework, such efforts may prove to be inadequate. Nonetheless, the risks associated with climate change are rapidly changing and evolving in an escalating fashion, making them difficult to assess due to limited data and other uncertainties. We could experience increased expenses resulting from strategic planning, litigation, and technology and market changes, and reputational harm as a result of negative public sentiment, regulatory scrutiny, and reduced investor and stakeholder confidence due to our response to climate change and our climate change strategy, which, in turn, could have a material negative impact on our business, results of operations, and financial condition.
Operational Risk
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. Our efforts to implement risk controls and loss mitigation actions, and the resources we devote to developing efficient procedures, identifying and rectifying weaknesses in existing procedures and training staff, may not be adequate or 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 rely on third party vendors to provide key components of our business infrastructure. We rely on numerous third parties to provide us with products and services necessary to maintain our day-to-day operations including, but not limited to, our core processing function and mortgage broker relationships. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements. The failure of an external vendor to perform in accordance with the contracted arrangements or service level agreements because of changes in the vendor’s organizational structure, financial condition, support for existing products and services or strategic focus or for any other reason, could be disruptive to our operations, which in turn could have a material negative impact on our financial condition and results of operations. We also could be adversely affected to the extent such an agreement is not renewed by the third party vendor or is renewed on terms less favorable to us. Additionally, the bank regulatory agencies expect financial institutions to be responsible for all aspects of our vendors’ performance, including aspects which they delegate to third parties. As a result, 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.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crime. Our Bank is susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our customers' or our information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation. Such fraudulent activity may take many forms, including wire fraud, check fraud, electronic fraud, phishing, social engineering and other dishonest acts. The reported incidents of fraud and other financial crimes have increased overall and we may experience material losses in the future that could have a material adverse effect on our reputation, business, financial condition and results of operations.
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Risks Related to Information Technology, Cybersecurity and Data Privacy
If the technology we use in operating our business fails, is unavailable, or does not operate to expectations, our business and results of operations could be adversely affected. Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems. Our policies and procedures to prevent or limit the impact of systems failures and interruptions may prove inadequate to prevent such events or to adequately address those events that we do experience. Even if we have well designed policies and procedures, we will remain vulnerable to such events. In addition, we outsource many aspects of our data processing and other operational functions to certain third-party providers, of particular significance is our long-term contract for core data processing with Fiserv. The contracts and relationships we have with our vendors may not place adequate controls around their actions, or they may breach those contracts. If our vendors encounter difficulties, including those resulting from disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches, or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. The failure of the systems on which we rely, or the termination or breach 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.
The occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse impact on our 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. Our future success will depend, in part, upon our ability and willingness 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.
Any significant disruption in or unauthorized access to our computer systems or those of third parties that we utilize in our operations, including those relating to cybersecurity or arising from cyber-attacks, could result in a loss or degradation of service or unauthorized disclosure of data, including customer and Company information, which could adversely affect our business. 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. Our computer systems and those of third parties we use in our operations are subject to cybersecurity threats, including, but not limited to: destructive malware, ransomware, attempts to gain unauthorized access to systems or data, unauthorized release of confidential information, corruption of data, networks or systems, zero-day attacks and malicious software. The measures in place to address and mitigate cyber-related risks may be inadequate and our investments in the cybersecurity and resiliency of our networks and to enhance our internal controls and processes may not be adequate 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. Cybersecurity risk management programs are expensive to maintain, and even well-designed and well-funded systems may not be effective against all potential cyber-attacks or security breaches. Moreover, as technology and cyberattacks change over time, we must continually monitor and change systems to guard against new threats. We may not know of or be able to guard against a new threat until after an attack has occurred.
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
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our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation and regulatory exposure, and severe harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations.
We are subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws could damage our reputation or otherwise adversely affect our business. Our business requires the collection and retention of volumes of customer data, including personally identifiable information (“PII”) in various information systems that we maintain and in those maintained by third party service providers. We also maintain important internal company data such as PII about our employees and information relating to our operations. We are subject to complex and evolving laws and regulations regarding the privacy and protection of PII of individuals (including customers, employees, and other third parties) including the Gramm-Leach-Bliley Act and the California Consumer Privacy Act. Various federal and state banking regulators and states have also enacted data breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in the event of a security breach. Ensuring that our collection, use, transfer and storage of PII complies with all applicable laws and regulations has increased, and is likely to continue increasing, our costs. Furthermore, we may not be able to ensure that customers and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information or where such information was intercepted or otherwise compromised by third parties), we could be exposed to litigation or regulatory sanctions under privacy and data protection laws and regulations. Concerns regarding the effectiveness of our measures to safeguard PII, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers and thereby reduce our revenue. Accordingly, any failure, or perceived failure, to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or result in significant liabilities, fines or penalties, and could damage our reputation and otherwise adversely affect our operations, financial condition and results of operations.
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 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 and 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.
We are no longer an “emerging growth company,” and as such, the cost of compliance with Section 404 of the Sarbanes-Oxley Act of 2002 may adversely affect our results of operations. Under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), management is required to annually assess and report on the effectiveness of our internal control over financial reporting and include an attestation report by the Company’s independent auditors addressing the effectiveness of our internal control over financial reporting. As an emerging growth company, we availed ourselves of the exemption from the requirement that our independent registered public accounting firm attest to the effectiveness of our internal control over financial reporting under Section 404. However, we may no longer avail ourselves of this exemption since we ceased to be an “emerging growth company” on December 31, 2022. As a result, our independent registered public accounting firm is required to undertake an assessment of our internal control over financial reporting and the cost of our compliance with Section 404 will correspondingly increase and require significant management time, which could adversely affect our 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 suspicious activity are examples of areas in which we are dependent on models and the data that underlies them. These quantitative techniques and approaches create the possibility that faulty data or flawed quantitative approaches could yield regulatory scrutiny or adverse outcomes, including increased exposure due to errors. Secondarily, because of the complexity inherent in these approaches, misunderstanding or misuse of their
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outputs could similarly result in suboptimal decision making, which could have a material adverse effect on our business, financial condition and results of operations.
Legal and Regulatory 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 them can impose additional compliance costs. Applicable laws and regulations 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 the Bank and/or Luther Burbank Corporation, as the Bank's holding company; inter-company transactions; 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, 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 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 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.
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 institutions 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, funding sources, 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.
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. Institutions which are deemed to have concentrations in CRE lending pursuant to the supervisory criteria in the relevant guidance 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, 2022, CRE loans represent 584% 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 560% 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
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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. Future regulatory change could impose higher capital standards on us. 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
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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.
Other Business Risks
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, financial technology companies, mortgage banking firms and online mortgage lenders, including large national financial institutions that operate in our market area, and with the United States Department of the Treasury. 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 lower the rates that we offer on loans and could require, and recently has required, us to increase the rates we pay on deposits, which could and recently has reduced 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.
Our reputation is critical to our business, and damage to it could have a material adverse effect on us. Our ability to attract and retain customers is highly dependent upon the perceptions of consumers and commercial borrowers and depositors and other external perceptions of our products, services, trustworthiness, business practices, workplace culture, compliance practice or our financial health. Negative public opinion or damage to our brand could result from actual or alleged conduct in any number of circumstances, including lending practices, regulatory compliance, security breaches, corporate governance, sales and marketing, and employee misconduct, as well as from our financial condition and performance. The policies and procedures we have in place to protect our reputation and promote ethical conduct may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, litigation, a decline in revenue and increased regulatory scrutiny.
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, 2022, the Trione Family Trusts control 78.4% 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 approve or 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 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 or if trading volumes do not provide sufficient liquidity.
Item 1B. Unresolved Staff Comments
None.
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 several loan production offices located throughout California. Other than our main branch in Santa Rosa, California, which we own, we lease all of our other offices.
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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 operation.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II.
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 February 17, 2023, we had approximately 3,005 record holders. On February 17, 2023, our stock closed at $12.17.
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 S&P U.S. BMI Banks - Western Region Index, which reflects the performance of publicly traded U.S. companies that do business as banks in the Western U.S., and (iii) the S&P U.S. BMI Banks Index, which reflects the performance of publicly traded U.S. banks that do business in the U.S.
The graph below assumes an initial $100 investment on December 31, 2017 through December 31, 2022. Data for the Company, the Russell 2000, the S&P U.S. BMI Banks - Western Region and the S&P U.S. BMI Banks 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.
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| Period Ended | ||||||||||||||||||||
| Index | 12/31/2017 | 12/31/2018 | 12/31/2019 | 12/31/2020 | 12/31/2021 | 12/31/2022 | ||||||||||||||
| Luther Burbank Corporation | 100.00 | 76.21 | 99.57 | 86.64 | 127.66 | 104.87 | ||||||||||||||
| Russell 2000 Index | 100.00 | 88.99 | 111.7 | 134.00 | 153.85 | 122.41 | ||||||||||||||
| S&P U.S. BMI Banks - Western Region | 100.00 | 79.17 | 96.55 | 72.25 | 111.40 | 86.45 | ||||||||||||||
| S&P U.S. BMI Banks | 100.00 | 83.54 | 114.74 | 100.10 | 136.10 | 112.89 | ||||||||||||||
| Source: S&P Capital IQ Pro | ||||||||||||||||||||
Dividend Policy
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.
Dividends are authorized at the sole discretion of our board of directors. In addition, our board of directors can change the amount or frequency of this dividend or discontinue the payment of dividends entirely at any time. Given the pending merger with WAFD, and the desire to preserve capital in the current uncertain economic environment, the Company’s board of directors, on January 24, 2023, decided to suspend any further quarterly cash dividends. 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, 2021 | $ | 0.06 | $ | 3,009 | |||||||
| Quarter ended June 30, 2021 | 0.06 | 3,006 | |||||||||
| Quarter ended September 30, 2021 | 0.12 | 6,217 | |||||||||
| Quarter ended December 31, 2021 | 0.12 | 6,214 | |||||||||
| Quarter ended March 31, 2022 | 0.12 | 6,225 | |||||||||
| Quarter ended June 30, 2022 | 0.12 | 6,126 | |||||||||
| Quarter ended September 30, 2022 | 0.12 | 6,139 | |||||||||
| Quarter ended December 31, 2022 | 0.12 | 6,138 | |||||||||
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 net profits for that year combined with the retained net profits for the preceding two 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
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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 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.
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, 2022 and 2021 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, 2020, 2019 and 2018 (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.
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| (Dollars in thousands, except per share data) | As of or For the Years Ended December 31, | |||||||||||||||||||||||||||||||
| 2022 | 2021 | 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||
| Statements of Income and Financial Condition Data | ||||||||||||||||||||||||||||||||
| Net income | $ | 80,198 | $ | 87,753 | $ | 39,912 | $ | 48,861 | $ | 45,060 | ||||||||||||||||||||||
Pre-tax, pre-provision net earnings (1) | $ | 114,887 | $ | 113,200 | $ | 67,209 | $ | 70,714 | $ | 66,531 | ||||||||||||||||||||||
| Total assets | $ | 7,974,632 | $ | 7,179,957 | $ | 6,906,104 | $ | 7,045,828 | $ | 6,937,212 | ||||||||||||||||||||||
| Per Common Share | ||||||||||||||||||||||||||||||||
| Diluted earnings per share | $ | 1.57 | $ | 1.70 | $ | 0.75 | $ | 0.87 | $ | 0.79 | ||||||||||||||||||||||
| Book value per share | $ | 13.36 | $ | 12.95 | $ | 11.75 | $ | 10.97 | $ | 10.31 | ||||||||||||||||||||||
Tangible book value per share (1) | $ | 13.30 | $ | 12.88 | $ | 11.69 | $ | 10.91 | $ | 10.25 | ||||||||||||||||||||||
| Selected Ratios | ||||||||||||||||||||||||||||||||
| Return on average: | ||||||||||||||||||||||||||||||||
| Assets | 1.06 | % | 1.22 | % | 0.56 | % | 0.69 | % | 0.70 | % | ||||||||||||||||||||||
| Stockholders' equity | 11.84 | % | 13.64 | % | 6.53 | % | 8.15 | % | 7.96 | % | ||||||||||||||||||||||
| Dividend payout ratio | 30.71 | % | 21.02 | % | 30.85 | % | 26.67 | % | 35.43 | % | ||||||||||||||||||||||
| Net interest margin | 2.39 | % | 2.40 | % | 1.97 | % | 1.84 | % | 1.98 | % | ||||||||||||||||||||||
Efficiency ratio (1) | 35.79 | % | 34.32 | % | 52.38 | % | 46.86 | % | 48.51 | % | ||||||||||||||||||||||
| Noninterest expense to average assets | 0.85 | % | 0.82 | % | 1.04 | % | 0.88 | % | 0.98 | % | ||||||||||||||||||||||
| Loan to deposit ratio | 120.06 | % | 113.71 | % | 114.92 | % | 119.03 | % | 122.59 | % | ||||||||||||||||||||||
| Credit Quality Ratios | ||||||||||||||||||||||||||||||||
| Allowance for loan losses to loans | 0.52 | % | 0.56 | % | 0.76 | % | 0.58 | % | 0.56 | % | ||||||||||||||||||||||
| Allowance for loan losses to nonperforming loans | 566.91 | % | 1,549.72 | % | 732.04 | % | 568.47 | % | 1,705.47 | % | ||||||||||||||||||||||
| Nonperforming assets to total assets | 0.08 | % | 0.03 | % | 0.09 | % | 0.09 | % | 0.03 | % | ||||||||||||||||||||||
| Net (recoveries) charge-offs to average loans | — | % | (0.00) | % | 0.01 | % | (0.01) | % | (0.01) | % | ||||||||||||||||||||||
| Capital Ratios | ||||||||||||||||||||||||||||||||
| Tier 1 leverage ratio | 9.72 | % | 10.12 | % | 9.45 | % | 9.47 | % | 9.42 | % | ||||||||||||||||||||||
| Total risk-based capital ratio | 19.14 | % | 19.61 | % | 18.60 | % | 17.97 | % | 17.20 | % | ||||||||||||||||||||||
(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. Pre-tax, pre-provision net earnings is defined as net income before taxes and provision for loan losses. 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. | ||||||||||||||||||||||||||||||||
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. 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, 2022, as compared to our results of operations for the year ended December 31, 2021, and our financial condition at December 31, 2022 as compared to our financial condition at December 31, 2021.
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.
Overview
We are a bank holding company headquartered in Santa Rosa, California, and the parent company of Luther Burbank Savings, a California-chartered commercial bank with $8.0 billion in assets at December 31, 2022. Our
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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 U.S. generally accepted accounting principles (“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, 2022. 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.
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 can be reduced by loan principal charge-offs, net of recoveries. The allowance can also be reduced by recapturing provisions when 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 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. In addition, we utilize a number of economic variables in estimating the allowance, with the most significant drivers being unemployment levels and housing prices. Material changes in these economic variables may result in incremental changes in the estimated level of our allowance. 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. The Company utilized the incurred loss methodology to determine its allowance for loan losses at December 31, 2022. The Company adopted the CECL allowance methodology on January 1, 2023. The impact of the adoption of CECL is still being evaluated but is not expected to have a material impact on our financial condition or results of operations.
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
29
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 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 and 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 the 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 Operations contain financial measures that are not measures recognized under GAAP and therefore, are considered non‐GAAP financial measures, including pre-tax, pre-provision net earnings, efficiency ratio, tangible assets, tangible stockholders' equity and tangible book value per share.
Our management uses these non‐GAAP financial measures in their analysis of the Company’s performance, financial condition and the efficiency of its operations. We believe that these non‐GAAP financial measures provide a greater understanding of ongoing operations and enhance comparability of results with prior periods and other companies, as well as demonstrate the effects of significant changes in the current period. We also believe that investors find these non‐GAAP financial measures useful as they assist investors in understanding our underlying operating performance and the analysis of ongoing operating trends. However, we acknowledge that our non-GAAP financial measures have a number of limitations. 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.
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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, | |||||||||||||||||||||||||||||||
| 2022 | 2021 | 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||
| Pre-tax, Pre-provision Net Earnings | ||||||||||||||||||||||||||||||||
| Income before provision for income taxes | $ | 113,737 | $ | 124,000 | $ | 56,659 | $ | 69,464 | $ | 62,931 | ||||||||||||||||||||||
| Plus: Provision for (reversal of) loan losses | 1,150 | (10,800) | 10,550 | 1,250 | 3,600 | |||||||||||||||||||||||||||
| Pre-tax, pre-provision net earnings | $ | 114,887 | $ | 113,200 | $ | 67,209 | $ | 70,714 | $ | 66,531 | ||||||||||||||||||||||
| Efficiency Ratio | ||||||||||||||||||||||||||||||||
| Noninterest expense (numerator) | $ | 64,027 | $ | 59,145 | $ | 73,934 | $ | 62,368 | $ | 62,687 | ||||||||||||||||||||||
| Net interest income | 177,254 | 170,459 | 138,623 | 128,407 | 125,087 | |||||||||||||||||||||||||||
| Noninterest income | 1,660 | 1,886 | 2,520 | 4,675 | 4,131 | |||||||||||||||||||||||||||
| Operating revenue (denominator) | $ | 178,914 | $ | 172,345 | $ | 141,143 | $ | 133,082 | $ | 129,218 | ||||||||||||||||||||||
| Efficiency ratio | 35.79 | % | 34.32 | % | 52.38 | % | 46.86 | % | 48.51 | % | ||||||||||||||||||||||
| Tangible Book Value Per Share | ||||||||||||||||||||||||||||||||
| Total assets | $ | 7,974,632 | $ | 7,179,957 | $ | 6,906,104 | $ | 7,045,828 | $ | 6,937,212 | ||||||||||||||||||||||
| Less: Goodwill | (3,297) | (3,297) | (3,297) | (3,297) | (3,297) | |||||||||||||||||||||||||||
| Tangible assets | 7,971,335 | 7,176,660 | 6,902,807 | 7,042,531 | 6,933,915 | |||||||||||||||||||||||||||
| Less: Total liabilities | (7,292,096) | (6,510,824) | (6,292,413) | (6,431,364) | (6,356,067) | |||||||||||||||||||||||||||
| Tangible stockholders' equity (numerator) | $ | 679,239 | $ | 665,836 | $ | 610,394 | $ | 611,167 | $ | 577,848 | ||||||||||||||||||||||
| Period end shares outstanding (denominator) | 51,073,272 | 51,682,398 | 52,220,266 | 55,999,754 | 56,379,066 | |||||||||||||||||||||||||||
| Tangible book value per share | $ | 13.30 | $ | 12.88 | $ | 11.69 | $ | 10.91 | $ | 10.25 | ||||||||||||||||||||||
Key Factors Affecting Our Business
Interest Rates
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’’, increases in interest rates, the pace of interest rate increases, and/or a flatter yield curve could have an adverse impact on our net interest income. Conversely, decreases in interest rates, particularly at the short end, and/or a steepened yield curve would be expected to benefit our net interest income.
Operating Efficiency
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. However, due to the current rising interest rate environment, which has generally had a greater impact on our cost of funds as compared to the yield on interest-earnings assets, our efficiency ratio may become a less relevant measure of our expense management. As an alternative, we believe that the comparison of our noninterest expense to total average assets will provide a better measure of our efficiency and expense management in this rate environment.
Credit Quality
We have well established loan policies and underwriting practices that have generally 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
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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.
Competition
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.
Economic Conditions
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 primarily 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.
Results of Operations - Years ended December 31, 2022 and 2021
Overview
For the year ended December 31, 2022 our net income was $80.2 million as compared to $87.8 million for the year ended December 31, 2021. The decrease of $7.6 million, or 8.6%, was primarily attributable to a $12.0 million increase in the provision for loan losses and a $4.9 million increase in noninterest expense, partially offset by an increase of $6.8 million in net interest income and a decrease of $2.7 million in the provision for income taxes as compared to the prior year. Pre-tax, pre-provision net earnings increased by $1.7 million, or 1.5%, for the year ended December 31, 2022 as compared to the prior year.
Net Interest Income
Net interest income totaled $177.3 million for the year ended December 31, 2022, an increase of $6.8 million, compared to the prior year primarily due to higher interest income on loans, partially offset by higher interest expense on our deposit portfolio.
Net interest margin for the year ended December 31, 2022 was 2.39%, compared to 2.40% for the prior year. Our net interest margin reflects the net impact of an increase in the cost of interest bearing liabilities, partially offset by an increase in the yield on interest earning assets. Due to the liability sensitivity of our balance sheet, our interest-bearing liabilities generally reprice more quickly than our interest-earning assets. Over the year, cost of our interest-bearing liabilities increased by 36 basis points primarily due to an increase in the cost of our deposits, while the yield on our interest-earning assets increased by 32 basis points primarily due to an increase in our loan yield. Our net interest spread for the year ended December 31, 2022 was 2.26%, decreasing by 4 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, 2022, 2021 and 2020. The average balances are daily averages.
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| For the Years Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | 2020 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Average Balance | Interest Inc/Exp | Yield/Rate | Average Balance | Interest Inc/Exp | Yield/Rate | Average Balance | Interest Inc/Exp | Yield/Rate | ||||||||||||||||||||||||||||||||||||||||||||
| Interest-Earning Assets | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Multifamily residential | $ | 4,375,648 | $ | 165,988 | 3.79 | % | $ | 4,199,639 | $ | 155,509 | 3.70 | % | $ | 4,063,607 | $ | 155,104 | 3.82 | % | |||||||||||||||||||||||||||||||||||
| Single family residential | 2,040,239 | 67,852 | 3.33 | % | 1,897,575 | 53,695 | 2.83 | % | 1,907,940 | 65,030 | 3.41 | % | |||||||||||||||||||||||||||||||||||||||||
| Commercial real estate | 185,908 | 8,673 | 4.67 | % | 196,456 | 8,893 | 4.53 | % | 206,639 | 9,530 | 4.61 | % | |||||||||||||||||||||||||||||||||||||||||
| Construction and land | 21,620 | 1,292 | 5.98 | % | 18,920 | 1,148 | 6.07 | % | 20,199 | 1,332 | 6.59 | % | |||||||||||||||||||||||||||||||||||||||||
Total loans (1) | 6,623,415 | 243,805 | 3.68 | % | 6,312,590 | 219,245 | 3.47 | % | 6,198,385 | 230,996 | 3.73 | % | |||||||||||||||||||||||||||||||||||||||||
| Investment securities | 654,794 | 14,372 | 2.19 | % | 653,479 | 8,451 | 1.29 | % | 647,174 | 9,856 | 1.52 | % | |||||||||||||||||||||||||||||||||||||||||
| Cash and cash equivalents | 142,802 | 2,776 | 1.94 | % | 150,166 | 223 | 0.15 | % | 185,246 | 538 | 0.29 | % | |||||||||||||||||||||||||||||||||||||||||
| Total interest-earning assets | 7,421,011 | 260,953 | 3.52 | % | 7,116,235 | 227,919 | 3.20 | % | 7,030,805 | 241,390 | 3.43 | % | |||||||||||||||||||||||||||||||||||||||||
Noninterest-earning assets (2) | 121,586 | 66,937 | 61,602 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total assets | $ | 7,542,597 | $ | 7,183,172 | $ | 7,092,407 | |||||||||||||||||||||||||||||||||||||||||||||||
| Interest-Bearing Liabilities | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Transaction accounts | $ | 171,077 | 431 | 0.25 | % | $ | 158,956 | 358 | 0.22 | % | $ | 178,655 | 876 | 0.48 | % | ||||||||||||||||||||||||||||||||||||||
| Money market demand accounts | 2,910,026 | 26,873 | 0.91 | % | 2,427,599 | 11,889 | 0.48 | % | 1,652,109 | 14,862 | 0.88 | % | |||||||||||||||||||||||||||||||||||||||||
| Time deposits | 2,432,642 | 29,179 | 1.19 | % | 2,750,461 | 23,365 | 0.84 | % | 3,390,992 | 57,593 | 1.67 | % | |||||||||||||||||||||||||||||||||||||||||
| Total deposits | 5,513,745 | 56,483 | 1.02 | % | 5,337,016 | 35,612 | 0.66 | % | 5,221,756 | 73,331 | 1.38 | % | |||||||||||||||||||||||||||||||||||||||||
| FHLB advances | 957,695 | 18,904 | 1.97 | % | 868,591 | 14,535 | 1.67 | % | 965,490 | 21,761 | 2.25 | % | |||||||||||||||||||||||||||||||||||||||||
| Junior subordinated debentures | 61,857 | 2,015 | 3.26 | % | 61,857 | 1,015 | 1.64 | % | 61,857 | 1,373 | 2.22 | % | |||||||||||||||||||||||||||||||||||||||||
| Senior debt | 94,719 | 6,297 | 6.65 | % | 94,596 | 6,298 | 6.66 | % | 94,473 | 6,302 | 6.67 | % | |||||||||||||||||||||||||||||||||||||||||
| Total interest-bearing liabilities | 6,628,016 | 83,699 | 1.26 | % | 6,362,060 | 57,460 | 0.90 | % | 6,343,576 | 102,767 | 1.60 | % | |||||||||||||||||||||||||||||||||||||||||
| Noninterest-bearing deposit accounts | 149,443 | 112,436 | 69,208 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Noninterest-bearing liabilities | 87,547 | 65,184 | 68,853 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total liabilities | 6,865,006 | 6,539,680 | 6,481,637 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total stockholders' equity | 677,591 | 643,492 | 610,770 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total liabilities and stockholders' equity | $ | 7,542,597 | $ | 7,183,172 | $ | 7,092,407 | |||||||||||||||||||||||||||||||||||||||||||||||
Net interest spread (3) | 2.26 | % | 2.30 | % | 1.83 | % | |||||||||||||||||||||||||||||||||||||||||||||||
Net interest income/margin (4) | $ | 177,254 | 2.39 | % | $ | 170,459 | 2.40 | % | $ | 138,623 | 1.97 | % | |||||||||||||||||||||||||||||||||||||||||
(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 $12.6 million, $19.6 million and $16.2 million for the years ended December 31, 2022, 2021 and 2020, 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.
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| For the Years Ended December 31, 2022 vs 2021 | |||||||||||||||||
| Variance Due To | |||||||||||||||||
| (Dollars in thousands) | Volume | Yield/Rate | Total | ||||||||||||||
| Interest-Earning Assets | |||||||||||||||||
| Multifamily residential | $ | 6,630 | $ | 3,849 | $ | 10,479 | |||||||||||
| Single family residential | 4,226 | 9,931 | 14,157 | ||||||||||||||
| Commercial real estate | (489) | 269 | (220) | ||||||||||||||
| Construction and land | 161 | (17) | 144 | ||||||||||||||
| Total Loans | 10,528 | 14,032 | 24,560 | ||||||||||||||
| Investment securities | 17 | 5,904 | 5,921 | ||||||||||||||
| Cash and cash equivalents | (12) | 2,565 | 2,553 | ||||||||||||||
| Total interest-earning assets | 10,533 | 22,501 | 33,034 | ||||||||||||||
| Interest-Bearing Liabilities | |||||||||||||||||
| Transaction accounts | 26 | 47 | 73 | ||||||||||||||
| Money market demand accounts | 2,721 | 12,263 | 14,984 | ||||||||||||||
| Time deposits | (2,902) | 8,716 | 5,814 | ||||||||||||||
| Total deposits | (155) | 21,026 | 20,871 | ||||||||||||||
| FHLB advances | 1,588 | 2,781 | 4,369 | ||||||||||||||
| Junior subordinated debentures | — | 1,000 | 1,000 | ||||||||||||||
| Senior debt | 8 | (9) | (1) | ||||||||||||||
| Total interest-bearing liabilities | 1,441 | 24,798 | 26,239 | ||||||||||||||
| Net Interest Income | $ | 9,092 | $ | (2,297) | $ | 6,795 | |||||||||||
| For the Years Ended December 31, 2021 vs 2020 | |||||||||||||||||
| Variance Due To | |||||||||||||||||
| (Dollars in thousands) | Volume | Yield/Rate | Total | ||||||||||||||
| Interest-Earning Assets | |||||||||||||||||
| Multifamily residential | $ | 5,240 | $ | (4,835) | $ | 405 | |||||||||||
| Single family residential | (350) | (10,985) | (11,335) | ||||||||||||||
| Commercial real estate | (471) | (166) | (637) | ||||||||||||||
| Construction and land | (82) | (102) | (184) | ||||||||||||||
| Total Loans | 4,337 | (16,088) | (11,751) | ||||||||||||||
| Investment securities | 95 | (1,500) | (1,405) | ||||||||||||||
| Cash and cash equivalents | (89) | (226) | (315) | ||||||||||||||
| Total interest-earning assets | 4,343 | (17,814) | (13,471) | ||||||||||||||
| Interest-Bearing Liabilities | |||||||||||||||||
| Transaction accounts | (88) | (430) | (518) | ||||||||||||||
| Money market demand accounts | 5,204 | (8,177) | (2,973) | ||||||||||||||
| Time deposits | (9,426) | (24,802) | (34,228) | ||||||||||||||
| Total deposits | (4,310) | (33,409) | (37,719) | ||||||||||||||
| FHLB advances | (2,025) | (5,201) | (7,226) | ||||||||||||||
| Junior subordinated debentures | — | (358) | (358) | ||||||||||||||
| Senior debt | 7 | (11) | (4) | ||||||||||||||
| Total interest-bearing liabilities | (6,328) | (38,979) | (45,307) | ||||||||||||||
| Net Interest Income | $ | 10,671 | $ | 21,165 | $ | 31,836 | |||||||||||
Total interest income increased by $33.0 million, or 14.5%, for the year ended December 31, 2022 as compared to the prior year. Interest income on loans increased $24.6 million to $243.8 million for the year ended December 31, 2022 from $219.2 million for the prior year. The improvement was primarily due to a 21 basis point increase in loan yields, as well as growth in the average balance of loans of $310.8 million during the period. The average balance
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of loans benefited from strong loan origination volumes and a slowing of prepayment speeds as compared to the same period last year, while loan yields improved as a result of a $17.6 million improvement in the earnings on our interest rate swaps hedging fixed rate loans, and a $7.0 million decrease in accelerated loan cost amortization on prepaid loans, as well as loans being originated at higher current interest rates.
During the years ended December 31, 2022 and 2021, total loans increased $713.0 million and $247.6 million, respectively. The volume of new loans originated totaled $2.1 billion and $2.4 billion for the years ended December 31, 2022 and 2021, respectively. Volume for the prior year includes the purchase of a $287.8 million pool of fixed rate single family loans in February 2021. The weighted average rate on new loans for the year ended December 31, 2022 was 4.00% compared to 3.30% for the prior year. The increase in the average coupon for current year originations compared to the prior year was due to the general higher level of market interest rates. During the year ended December 31, 2022, the Federal Open Market Committee increased the federal funds rate by 425 basis points. Loan payoffs and paydowns totaled $1.4 billion and $2.1 billion for the years ended December 31, 2022 and 2021, respectively. The decrease in prepayments was due to rising market interest rates, which impacted refinancing activity during the current year. The weighted average rate on loan payoffs during the year ended December 31, 2022 was 3.85% as compared to 3.93% for the prior year.
Total interest expense increased $26.2 million to $83.7 million for the year ended December 31, 2022 from $57.5 million for the prior year. Interest expense on deposits increased $20.9 million to $56.5 million for the year ended December 31, 2022 from $35.6 million for the prior year. This increase was primarily due to the cost of interest-bearing deposits increasing 36 basis points predominantly due to our deposit portfolio repricing to higher current market interest rates. Additionally, interest expense on advances from the FHLB increased by $4.4 million during the year ended December 31, 2022 as compared to the prior year due to increases in the average balance and cost of FHLB advances of $89.1 million and 30 basis points, respectively. The increase in the cost of FHLB advances was due to rising market interest rates. We generally use both deposits and FHLB advances to fund net loan growth. We also use FHLB advances, with or without embedded interest rate caps, as a hedge of interest rate risk, as we can strategically control the duration of those funds. A discussion of instruments used to mitigate interest rate risk can be found under Part II - Item 7A. ‘‘Quantitative and Qualitative Disclosures About Market Risk.’’
Provision for Loan Losses
During the year ended December 31, 2022, provisions for loan losses totaled $1.2 million, compared to a reversal of provisions for loan losses of $10.8 million for the year ended December 31, 2021. During the year ended December 31, 2022, loan loss provisions were recorded primarily due to loan growth and incremental changes in classified loan balances, partially offset by a reversal of loan loss provisions related to the remaining portion of qualitative reserves established early in the pandemic for uncertain economic risks that were no longer deemed necessary. The recaptured loan loss provisions during the prior year were predominantly due to the reversal of a portion of our pandemic related qualitative reserves.
Nonperforming loans totaled $6.5 million and $2.3 million, or 0.09% and 0.04% of total loans, at December 31, 2022 and 2021, respectively. The increase in nonperforming assets was primarily due to one previously classified loan that was moved to nonaccrual status during the current year. Classified loans, which includes loans graded Substandard and of greater risk, totaled $18.9 million and $12.1 million at December 31, 2022 and 2021, respectively. Criticized loans, which includes loans graded Special Mention and classified loans, were $22.3 million at December 31, 2022 compared to $16.7 million at December 31, 2021. The increase in classified and criticized loan balances was primarily attributed to isolated credit related downgrades of several loans and is not thought to represent any particular declining credit trends in our loan portfolio. Our allowance for loan losses as a percentage of total loans was 0.52% at December 31, 2022 as compared to 0.56% at December 31, 2021.
Noninterest Income
Noninterest income decreased by $226 thousand to $1.7 million for the year ended December 31, 2022 from $1.9 million for the year ended December 31, 2021. The following table presents the major components of our noninterest income:
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| For the Years Ended December 31, | |||||||||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | $ Increase (Decrease) | % Increase (Decrease) | |||||||||||||||||||
| Noninterest Income | |||||||||||||||||||||||
| FHLB dividends | $ | 1,588 | $ | 1,558 | $ | 30 | 1.9 | % | |||||||||||||||
| Fee income | 750 | 420 | 330 | 78.6 | % | ||||||||||||||||||
| Other | (678) | (92) | (586) | 637.0 | % | ||||||||||||||||||
| Total noninterest income | $ | 1,660 | $ | 1,886 | $ | (226) | (12.0) | % | |||||||||||||||
The decrease in noninterest income for the year ended December 31, 2022 compared to the year ended December 31, 2021 was primarily due to a $1.4 million decline in market value on equity securities recorded during the current year compared to a decline in market value of $344 thousand recorded during the prior year, both attributed to the rise in market interest rates. This decrease was partially offset by a $366 increase in income earned on CRA qualified investments and a $330 thousand increase in servicing fee income due to slower fair value declines in our mortgage servicing rights due to higher current market interest rates.
Noninterest Expense
Noninterest expense increased $4.9 million, or 8.3%, to $64.0 million for the year ended December 31, 2022 from $59.1 million for 2021. The following table presents the components of our noninterest expense:
| For the Years Ended December 31, | |||||||||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | $ Increase (Decrease) | % Increase (Decrease) | |||||||||||||||||||
| Noninterest Expense | |||||||||||||||||||||||
| Compensation and related benefits | $ | 38,185 | $ | 38,624 | $ | (439) | (1.1) | % | |||||||||||||||
| Deposit insurance premium | 2,019 | 1,920 | 99 | 5.2 | % | ||||||||||||||||||
| Professional and regulatory fees | 2,441 | 1,976 | 465 | 23.5 | % | ||||||||||||||||||
| Occupancy | 4,781 | 4,933 | (152) | (3.1) | % | ||||||||||||||||||
| Depreciation and amortization | 2,949 | 2,561 | 388 | 15.2 | % | ||||||||||||||||||
| Data processing | 4,089 | 3,785 | 304 | 8.0 | % | ||||||||||||||||||
| Marketing | 3,512 | 1,240 | 2,272 | 183.2 | % | ||||||||||||||||||
| Merger costs | 1,090 | — | 1,090 | N/A | |||||||||||||||||||
| Other expenses | 4,961 | 4,106 | 855 | 20.8 | % | ||||||||||||||||||
| Total noninterest expense | $ | 64,027 | $ | 59,145 | $ | 4,882 | 8.3 | % | |||||||||||||||
The increase in noninterest expense during the year ended December 31, 2022 as compared to the prior year was primarily attributable to a $2.3 million increase in marketing costs related to deposit gathering efforts and $1.0 million of costs incurred in connection with our previously announced merger with WAFD. Additionally, other expenses increased primarily due to an $807 thousand increase in down payment assistance costs associated with our Daisy program to support home ownership for low-to-moderate income borrowers. Our efficiency ratio was 35.8% for the year ended December 31, 2022 compared to 34.3% for the prior year.
Income Tax Expense
For the years ended December 31, 2022 and 2021, we recorded income tax expense of $33.5 million and $36.2 million, respectively, with effective tax rates of 29.5% and 29.2%, respectively.
Financial Condition - As of December 31, 2022 and 2021
Total assets at December 31, 2022 were $8.0 billion, an increase of $794.7 million, or 11.1%, from December 31, 2021. The increase was primarily due to a $713.0 million increase in loans as compared to the prior year-end. Total liabilities were $7.3 billion at year end, an increase of $781.3 million, or 12.0%, from December 31, 2021. The increase in total liabilities was primarily attributable to a $456.5 million increase in FHLB advances and growth in our deposits of $301.1 million.
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Loan Portfolio Composition
Our loan portfolio is our largest class of earning assets and typically provides higher yields than other types of earning assets. Associated with the higher yields is an inherent amount of credit risk which we attempt to mitigate with strong underwriting. As of December 31, 2022 and 2021, our total loans amounted to $7.0 billion and $6.3 billion, respectively. The following table presents the balance and associated percentage of each major product type within our portfolio as of the dates indicated.
| As of December 31, | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | 2020 | 2019 | 2018 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Amount | % of total | Amount | % of total | Amount | % of total | Amount | % of total | Amount | % of total | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Real estate loans | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Multifamily residential | $ | 4,500,500 | 64.8 | % | $ | 4,183,194 | 66.9 | % | $ | 4,075,893 | 67.9 | % | $ | 3,962,929 | 64.1 | % | $ | 3,650,967 | 60.1 | % | ||||||||||||||||||||||||||||||||||||||||||
| Single family residential | 2,253,987 | 32.4 | % | 1,859,524 | 29.8 | % | 1,700,119 | 28.3 | % | 1,993,484 | 32.3 | % | 2,231,802 | 36.7 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Commercial real estate | 171,767 | 2.5 | % | 186,531 | 3.0 | % | 202,189 | 3.4 | % | 202,452 | 3.3 | % | 183,559 | 3.0 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Construction and land | 22,533 | 0.3 | % | 18,094 | 0.3 | % | 22,241 | 0.4 | % | 20,665 | 0.3 | % | 12,756 | 0.2 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Total loans before deferred items | 6,948,787 | 100.0 | % | 6,247,343 | 100.0 | % | 6,000,442 | 100.0 | % | 6,179,530 | 100.0 | % | 6,079,084 | 100.0 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Deferred loan costs, net | 61,658 | 50,077 | 49,374 | 51,447 | 51,546 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total loans | $ | 7,010,445 | $ | 6,297,420 | $ | 6,049,816 | $ | 6,230,977 | $ | 6,130,630 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
The relative composition of the loan portfolio has not changed significantly over the past few years. Our primary focus remains multifamily real estate lending, which constituted 65% and 67% of our portfolio at December 31, 2022 and 2021, respectively. Single family residential lending is our secondary lending emphasis and represented 32% and 30% of our portfolio at December 31, 2022 and 2021, respectively.
We recognize that our multifamily and single family residential loan products represent concentrations within our balance sheet. Multifamily loan balances as a percentage of risk-based capital were 560% and 551% as of December 31, 2022 and 2021, respectively. Our single family loans as a percentage of risk-based capital were 281% and 246% as of the same dates. Additionally, our loans are geographically concentrated with borrowers and collateral properties on the West Coast. At December 31, 2022, 61%, 27% and 9% of our real estate loans were collateralized by properties in southern California counties, northern California counties and Washington, respectively, compared to 63%, 26% and 9%, respectively, at December 31, 2021.
Our lending strategy has been to focus on products and markets where we have significant expertise. Given our concentrations, we have established strong risk management practices including risk-based lending standards, self-established product and geographical limits, annual cash flow evaluations of income property loans and semi-annual stress testing.
We have a small portfolio of construction loans with commitments (funded and unfunded) totaling $38.7 million and $38.1 million at December 31, 2022 and 2021, respectively. As of December 31, 2022, the average loan commitment for our single family construction product, which includes small tract housing and condominium projects, and our multifamily residential construction loans was $5.7 million and $3.4 million, respectively, compared to $5.1 million and $6.4 million, respectively, at December 31, 2021. Our construction lending typically focuses on non-owner occupied single family residential projects with completed per-unit values of $4.0 million or less and multifamily projects with loan commitments of $15.0 million or less. In late 2022, we stopped accepting any new construction loan applications.
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The following table presents the activity in our loan portfolio for the periods shown:
| For the Years Ended December 31, | |||||||||||||||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | 2020 | 2019 | 2018 | ||||||||||||||||||||||||
| Loan increases: | |||||||||||||||||||||||||||||
| Multifamily residential | $ | 1,193,933 | $ | 1,282,311 | $ | 904,588 | $ | 891,116 | $ | 1,119,617 | |||||||||||||||||||
| Single family residential | 881,290 | 768,614 | 494,753 | 591,177 | 828,907 | ||||||||||||||||||||||||
| Commercial real estate | 24,471 | 2,000 | 12,106 | 38,088 | 84,808 | ||||||||||||||||||||||||
| Construction and land | 13,699 | 27,612 | 9,583 | 33,618 | 14,555 | ||||||||||||||||||||||||
| Purchases | — | 287,751 | 20,380 | 10,052 | — | ||||||||||||||||||||||||
| Total loans originated and purchased | 2,113,393 | 2,368,288 | 1,441,410 | 1,564,051 | 2,047,887 | ||||||||||||||||||||||||
| Loan decreases: | |||||||||||||||||||||||||||||
| Loan principal reductions and payoffs | (1,398,372) | (2,095,438) | (1,640,597) | (1,376,413) | (956,578) | ||||||||||||||||||||||||
| Portfolio loan sales | — | (1,706) | (825) | (68,325) | (19,603) | ||||||||||||||||||||||||
Other (1) | (1,996) | (23,540) | 18,851 | (18,966) | 17,377 | ||||||||||||||||||||||||
| Total loan outflows | (1,400,368) | (2,120,684) | (1,622,571) | (1,463,704) | (958,804) | ||||||||||||||||||||||||
| Net change in total loan portfolio | $ | 713,025 | $ | 247,604 | $ | (181,161) | $ | 100,347 | $ | 1,089,083 | |||||||||||||||||||
(1) Other changes in loan balances primarily represent the net change in disbursements on unfunded commitments, deferred loan costs, fair value adjustments and, to the extent applicable, may include foreclosures, charge-offs, negative amortization and interest capitalized as a result of COVID-19 modifications. | |||||||||||||||||||||||||||||
Our loan portfolio increased $713.0 million during the year ended December 31, 2022. The growth of our loan portfolio was primarily due to new loan originations exceeding $2.1 billion and a decrease of $697.1 million in loan curtailments as compared to the prior year due to a slowing of refinancing activity correlated with the increase in market interest rates. Loan prepayment speeds were 18.2% and 27.4% during the years ended December 31, 2022 and 2021, respectively.
Multifamily residential loans. We provide multifamily residential loans for the purchase or refinance of apartment buildings of five units or more, with the financed properties serving as collateral for the loan. Our multifamily lending is built around three core principles: market selection, deal selection and sponsor selection. 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. We typically lend on stabilized and seasoned assets and focus on older, smaller properties with rents at or below market levels, catering to low and middle income renters. Our customers are generally experienced real estate professionals who desire regular income/cash flow streams and are focused on building wealth steadily over time. We have instituted strong lending policies to mitigate credit and concentration risk. At December 31, 2022, our multifamily real estate portfolio had an average loan balance of $1.7 million, an average unit count of 13.7 units, a weighted average loan to value of 56.7% and a weighted average debt service coverage ratio of 1.5 times, as compared to an average loan balance of $1.6 million, an average unit count of 14.0 units, a weighted average loan to value of 56.9% and a weighted average debt service coverage ratio of 1.5 times at December 31, 2021.
Single family residential loans. We provide permanent financing on single family residential properties primarily located in our market areas, which are both owner-occupied and investor owned. We conduct this business primarily through a network of third party mortgage brokers with the intention of retaining these loans in our portfolio. The majority of our originations are for purchase transactions, but we also provide loans to refinance single family properties. Our underwriting criteria focuses on debt ratios, credit scores, liquidity of the borrower and the borrower’s cash reserves. At December 31, 2022, our single family residential real estate portfolio had an average loan balance of $907 thousand, a weighted average loan to value of 64.0% and a weighted average borrower credit score at origination/refreshed of 759. At December 31, 2021, our single family residential real estate portfolio had an average loan balance of $859 thousand, a weighted average loan to value of 62.5% and a weighted average borrower credit score at origination/refreshed of 759.
Commercial real estate loans. While not a large part of our portfolio during any period presented, we also lend on nonresidential commercial real estate. Our nonresidential commercial real estate loans are generally used to finance the purchase or refinance of established multi-tenant industrial, office and retail sites. At December 31,
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2022, our commercial real estate portfolio had an average loan balance of $2.2 million, a weighted average loan to value of 53.9% and a weighted average debt service coverage ratio of 1.7 times, as compared to an average loan balance of $2.1 million, a weighted average loan to value of 54.2% and a weighted average debt service coverage ratio of 1.7 times at December 31, 2021.
Construction and land. Other categories of loans included in our portfolio consist of construction and land loans. Construction loans include a single family construction product, which includes small tract housing and condominium projects, and multifamily construction projects. As of December 31, 2022 and 2021, the Company had no land loans outstanding.
The following table sets forth the contractual maturity distribution of our loan portfolio:
| (Dollars in thousands) | Due in 1 year or less | Due after 1 year through 5 years | Due after 5 years through 15 years | Due after 15 years | Total | ||||||||||||
| As of December 31, 2022: | |||||||||||||||||
| Loans | |||||||||||||||||
| Real estate mortgage loans: | |||||||||||||||||
| Multifamily residential | $ | 72 | $ | 537 | $ | 39,917 | $ | 4,459,974 | $ | 4,500,500 | |||||||
| Single family residential | 27 | 468 | 51,443 | 2,202,049 | 2,253,987 | ||||||||||||
| Commercial real estate | — | 41,505 | 130,262 | — | 171,767 | ||||||||||||
| Construction and land | 17,464 | 5,069 | — | — | 22,533 | ||||||||||||
| Total loans | $ | 17,563 | $ | 47,579 | $ | 221,622 | $ | 6,662,023 | $ | 6,948,787 | |||||||
| Fixed interest rates | $ | — | $ | 197 | $ | 45,045 | $ | 270,285 | $ | 315,527 | |||||||
| Floating or hybrid adjustable rates | 17,563 | 47,382 | 176,577 | 6,391,738 | 6,633,260 | ||||||||||||
| Total loans | $ | 17,563 | $ | 47,579 | $ | 221,622 | $ | 6,662,023 | $ | 6,948,787 | |||||||
| As of December 31, 2021: | |||||||||||||||||
| Loans | |||||||||||||||||
| Real estate mortgage loans: | |||||||||||||||||
| Multifamily residential | $ | 30 | $ | 2,225 | $ | 37,730 | $ | 4,143,209 | $ | 4,183,194 | |||||||
| Single family residential | 27 | 631 | 56,858 | 1,802,008 | 1,859,524 | ||||||||||||
| Commercial real estate | — | 11,403 | 175,128 | — | 186,531 | ||||||||||||
| Construction and land | 10,648 | 7,446 | — | — | 18,094 | ||||||||||||
| Total loans | $ | 10,705 | $ | 21,705 | $ | 269,716 | $ | 5,945,217 | $ | 6,247,343 | |||||||
| Fixed interest rates | $ | — | $ | 201 | $ | 49,385 | $ | 240,337 | $ | 289,923 | |||||||
| Floating or hybrid adjustable rates | 10,705 | 21,504 | 220,331 | 5,704,880 | 5,957,420 | ||||||||||||
| Total loans | $ | 10,705 | $ | 21,705 | $ | 269,716 | $ | 5,945,217 | $ | 6,247,343 | |||||||
Our fixed interest rate loans generally consist of 30 and 40-year loans that are primarily secured by single family residential properties, often in conjunction with our efforts to provide affordable housing financing to low-to-moderate income individuals. Our floating and adjustable rate loans are largely hybrid interest rate programs that provide an initial fixed term of three to ten years and then convert to quarterly or semi-annual repricing adjustments thereafter. As of December 31, 2022 and 2021, $4.6 billion and $4.8 billion, respectively, of our floating or hybrid adjustable rate loans were at their floor rates. The weighted average minimum interest rate on loans at their floor rates was 3.66% and 3.75% at December 31, 2022 and 2021, respectively. Hybrid adjustable rate loans still within their initial fixed term totaled $5.7 billion and $5.1 billion at December 31, 2022 and 2021, respectively. These loans had a weighted average term to first repricing date of 3.7 years and 3.6 years at December 31, 2022 and 2021, respectively.
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Asset Quality
Our primary objective is to maintain a high level of asset quality in our loan portfolio. We believe our underwriting practices and policies, established by experienced professionals, appropriately govern the risk profile for our loan portfolio. These policies are continually evaluated and updated as necessary. All loans are assessed and assigned a risk classification at origination based on underlying characteristics of the transaction such as collateral type, collateral cash flow, collateral coverage and borrower strength. We believe that we have a comprehensive methodology to proactively monitor our credit quality after origination. Particular emphasis is placed on our commercial portfolio where risk assessments are re-evaluated as a result of reviewing commercial property operating statements and borrower financials on at least an annual basis. Single family residential loans are subject to an annual regrading based upon a credit score refresh, among other factors. On an ongoing basis, we also monitor payment performance, delinquencies, and tax and property insurance compliance, as well as any other pertinent information that may be available to determine the collectability of a loan. We believe our practices facilitate the early detection and remediation of problems within our loan portfolio. Assigned risk ratings, as well as the evaluation of other credit metrics, are an integral part of management assessing the adequacy of our allowance for loan losses. We periodically employ the use of an outside independent consulting firm to evaluate our underwriting and risk assessment processes. Like other financial institutions, we are subject to the risk that our loan portfolio will be exposed to increasing pressures from deteriorating borrower credit due to general economic conditions.
Nonperforming assets. Our nonperforming assets consist of nonperforming loans and foreclosed real estate, if any. It is our policy to place a loan on non-accrual status in the event that the borrower is 90 days or more delinquent, unless the loan is well secured and in the process of collection, or earlier if the timely collection of contractual payments appears doubtful. Cash payments subsequently received on non-accrual loans are recognized as income only where the future collection of the remaining principal is considered by management to be probable. Loans are restored to accrual status only when the loan is less than 90 days delinquent and not in foreclosure, and the borrower has demonstrated the ability to make future payments of principal and interest.
Troubled debt restructurings. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings ("TDRs"). Concessions could include reductions of interest rates, extension of the maturity date at a rate lower than the current market rate for a new loan with similar risk, reduction of accrued interest, principal forgiveness, forbearance, or other material modifications. The assessment of whether a borrower is experiencing or will likely experience financial difficulty and whether a concession has been granted is highly subjective in nature, and management’s judgment is required when determining whether a modification is classified as a TDR.
In conjunction with the passage 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 were provided the option, for loans meeting specific criteria, to temporarily suspend certain requirements under GAAP related to TDRs for a limited time to account for the effects of COVID-19. As a result, the Company did not recognize eligible COVID-19 loan modifications as TDRs. Additionally, loans qualifying for these modifications were not required to be reported as delinquent, non-accrual, impaired or criticized solely as a result of a COVID-19 loan modification. Since June 2021, all loans modified for pandemic related payment deferral had returned to scheduled payments or were paid off in full.
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