10-K 1 fcbp-123119x10xk.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________________________
Form 10-K
_________________________________________________________________
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-38476
_________________________________________________________________
fcblogoa10.gif
(Exact name of Registrant as specified in its charter)
_________________________________________________________________
California
 
 
 
82-2711227
(State or Other Jurisdiction of
 
 
 
(I.R.S. Employer
Incorporation or Organization)
 
 
 
Identification Number)
 
 
 
 
 
17785 Center Court Drive N., Suite 750
Cerritos, CA
 
 
 
90703
(Address of principal executive offices)
 
 
 
(Zip Code)
Registrant’s telephone number, including area code: 562-345-9092

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Shares, no par value
FCBP
 Nasdaq Capital Market

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 ☐ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ 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 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ☐




Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes x No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer
Accelerated Filer
x
Non-accelerated filer
Smaller reporting company
x
Emerging Growth Company
x
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the Registrant was approximately $228,150,534 based on the closing price of the common stock of $22.74 as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2019) as reported by the Nasdaq Global Select Market. The market value of shares held by registrant’s directors and executive officers have been excluded because they may be considered to be affiliates of the registrant.

As of March 2, 2020, the Registrant had 11,690,103 shares outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive proxy statement relating to Registrant’s 2020 Annual Meeting of Shareholders, which will be filed within 120 days of the fiscal year ended December 31, 2019, scheduled to be held on June 16, 2020, are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.




INDEX


TABLE OF CONTENTS


    

 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
PART II.
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
PART III.
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
PART IV.
 
Item 15.
Item 16.
 
 
 
 





CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

In this Annual Report on Form 10-K, the terms “First Choice Bancorp,” “Bancorp,” or the “holding company” refer to First Choice Bancorp on a stand-alone basis, and the term “Bank” refers to Bancorp's wholly-owned subsidiary, First Choice Bank. The terms “we,” “us,”, “our” or the “Company” refer to First Choice Bancorp and First Choice Bank collectively and on a consolidated basis. The statements in this report include forward looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform act of 1995 regarding management’s beliefs, projections and assumptions concerning future results and events. Forward-looking statements include descriptions of management’s plans or objectives for future operations, products or services, and forecasts of the Company’s revenues, earnings or other measures of economic performance. These forward-looking statements involve risks and uncertainties and are based on management's beliefs and assumptions and on the information available to management at the time that this report was prepared and can be identified by the fact that they do not relate strictly to historical or current facts. They often include the words or phrases such as "aim," "can," "may," "could," "predict," "should," "will," "would," "believe," "anticipate," "estimate," "expect," "hope," "intend," "plan," "potential," "project," "will likely result," "continue," "seek," "shall," "possible," "projection," "optimistic," and "outlook," and variations of these words and similar expressions or the negative version of those words or phrases.

Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Risks and uncertainties that could cause our financial performance to differ materially from our goals, plans, expectations and projections expressed in forward-looking statements include those set forth in our filings with the SEC, Item 1A of our Annual Report on Form 10-K, and the following:

The effects of trade, monetary and fiscal policies and laws.
Possible losses of businesses and population in the Los Angeles, Orange, or San Diego Counties.
Loss of customer checking and money-market account deposits as customers pursue other higher-yield investments.
Possible changes in consumer and business spending and saving habits and the related effect on our ability to increase assets and to attract deposits.
Possible changes in the creditworthiness of customers and the possible impairment of the collectability of loans.
Changes in the speed of loan prepayments, loan origination and sale volumes, loan loss provisions, charge-offs or actual loan losses.
Compression of our net interest margin.
Inability of our framework to manage risks associated with our business, including but not limited to operational risk, regulatory risk, cyber risk, liquidity risk, customer risk and credit risk, to mitigate all risk or loss to us.
The effects of any damage to our reputation resulting from developments related to any of the items identified above.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included herein. These and other factors are further described in this Annual Report on Form 10-K at Item 1A “Risk Factors”.

Forward-looking statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events and specifically disclaims any obligation to revise or update such forward-looking statements for any reason, except as may be required by applicable law. You should consider any forward-looking statements in light of this explanation, and we caution you about relying on forward-looking statements.


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PART I

ITEM 1. BUSINESS
 
Overview

First Choice Bancorp, a California corporation, was organized on September 1, 2017 to serve as the holding company for its wholly-owned subsidiary, First Choice Bank, a California state-chartered commercial bank. On December 21, 2017, the Bank received requisite shareholder and regulatory approvals for the Bank to reorganize into the holding company form of ownership pursuant to which the Bank became a wholly-owned subsidiary of First Choice Bancorp. We are regulated as a bank holding company by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the Bank is regulated by the California Department of Business Oversight ("DBO") and, as a member bank, of the Federal Reserve.

Our headquarters is located at 17785 Center Court Drive N., Suite 750, Cerritos, California 90703, and our telephone number at that location is (562) 345-9092. Our common stock began trading on the NASDAQ Stock Market under the trading symbol of “FCBP” on May 1, 2018.

Acquisition and Expansion

Effective July 31, 2018, we acquired Pacific Commerce Bancorp ("PCB") and its wholly-owned subsidiary bank, Pacific Commerce Bank, by merger in an all-stock transaction. The acquisition has been accounted for using the acquisition method of accounting and, accordingly, the operating results of PCB have been included in the consolidated financial statements from August 1, 2018. See also Note 2. Business Combinations to the Consolidated Financial Statements in Part II, Item 8. Financial Statements and Supplementary Data, in this Annual Report.
 
Business of the Bank

The Bank was incorporated under the laws of the State of California in March 2005, is licensed by the DBO, and commenced banking operations in August 2005 as a California state-chartered commercial bank headquartered in Cerritos, California. On October 1, 2018, the Bank became a state member bank of the Federal Reserve. Accordingly, the Bank is subject to periodic examination and supervision by the DBO and by the Federal Reserve as the Bank's primary regulators. In addition, the Bank's deposits are insured under the Federal Deposit Insurance Act by the Federal Deposit Insurance Corporation ("FDIC") and, as a result, the FDIC has examination authority over the Bank.

The Bank is a full-service commercial bank offering a broad range of retail and commercial banking products and services to individuals and businesses. Our primary market area is broadly defined as Southern California, which includes Los Angeles, Orange, San Diego, Ventura, Riverside, San Bernardino and Imperial Counties of California, with a particular focus on Los Angeles, Orange and San Diego Counties. We operate nine full-service branches located in Alhambra, Anaheim, Carlsbad, Cerritos, Chula Vista, Downtown Los Angeles, Pasadena, Rowland Heights, and West Los Angeles, and two loan production offices located in Manhattan Beach and San Diego, California. We also maintain the brand name ProAmérica.
 
We focus on offering banking products and services designed for small- and medium-sized businesses, non-profit organizations, business owners and entrepreneurs, and the professional community, including attorneys, certified public accountants, financial advisors, healthcare providers and investors, who need the personalized and responsive service of a local bank with accessible, top-level decision makers who know the individual community. We target these potential customers who prefer to have a relationship with an institution where decisions are made locally and its employees know them and their business personally. Our deposit products consist primarily of checking, money market, savings, and certificates of deposit accounts. Our lending products consist primarily of construction and land development loans, commercial real estate ("CRE") loans, commercial and industrial ("C&I") loans, and U.S. Small Business Administration ("SBA") loans. We also provide Treasury Management services, online banking, mobile banking, and credit cards (offered under a private labeling arrangement with a correspondent bank) and other primarily business-oriented products.
 
Our mission is to increase economic opportunity and promote community development investments, job creation, business development, affordable housing, financial literacy and philanthropic support for the under-served populations in economically distressed communities in the areas of our operations and to generally serve the business needs of those doing business in Southern California. While a majority of the members of our Board of Directors and our employees are members of a minority community, we are committed to serving all communities in our Southern California market area. We provide support to the communities that we serve in the form of financial grants and service hours to many local non-profit

5


organizations. We also partner with non–profit institutions in providing micro loans to help business owners and entrepreneurs within our communities.
 
Strategy
 
Our strategic objective focuses on offering business-oriented loans and deposits products, financial solutions, and relationship banking services to customers located throughout Southern California, with a focus on Los Angeles, Orange, and San Diego counties. Our customers are business owners and entrepreneurs of small- and medium-sized businesses, non-profit organizations; professionals, including attorneys, certified public accountants, financial advisors and healthcare providers and high-net worth individuals. Our value proposition is to provide a premier business banking experience through relationship banking, depth of expertise, resources and products while maintaining disciplined credit underwriting standards and continuing our focus on our operational efficiency. We focus on originating high-quality loans and growing our deposit base through our relationship-based business lending. We pride ourselves on being “First in Speed, Service and Solutions.” Our objective is to serve most segments of the business community within our market area. The key components of our strategy and business plan include the following:
 
customer service, including a high level of personal service and responsiveness;

relationship banking by experts in their fields, including private banking, commercial banking, and real estate;

banking and financial service products for businesses, professionals and high net worth individuals, including products and services similar to those offered by larger banks;

leveraging our existing infrastructure with improvements in technology and processes to gain efficiencies to support a larger volume of business;

an experienced management team with roots in our market areas; and

strong community commitment.
 
We believe that the investments in experienced relationship management will establish an infrastructure to support our future.
 
Marketing Strategy
 
To fulfill our mission, we target the marketing of our products and services toward the small- to middle-market segments of the business community. The small- to middle- business market, generally defined as companies with revenues of less than $50 million, is our primary commercial banking target market. At December 31, 2019, our capital allowed us to provide unsecured lending (defined as a loan not secured by a first deed of trust on real estate or cash collateral) and secured lending (defined as a loan secured by a first deed of trust on real estate or cash collateral) to a single borrower up to a maximum of $31 million and $52 million, respectively. However, we generally limit our lending commitments to a lower level, currently set at $15 million (the “house limit”), unless the relationship is specifically approved by our Directors’ Loan Committee. Our relationship managers, directors and executive officers are uniquely qualified to support our marketing plan, having deep roots in many of the communities within our target market.
 
Our directors and officers are actively involved in local community groups and service organizations. Accordingly, our marketing strategy anticipates our ability to respond quickly to customer needs and changes in the market place. Because we are locally-owned and operated, with a management team and Board of Directors charged with monitoring the financial needs of our communities, we are in a position to respond promptly to the requirements of potential new customers, as well as the changing needs of our existing customers.
 
Our strategy includes the retention of experienced and proven bankers as relationship managers who are familiar with our market area, along with a full offering of products. This provides each of our customers with access to a strong trusted advisor, who can offer knowledgeable advice and an extensive suite of products, including state of the art remote deposit products and specialized personnel for non-deposit products. Our approach is to staff offices with experienced bankers who are familiar with the area and preferably live or have worked in the area.

Products Offered
 
We offer a full array of competitively priced commercial loan and deposit products, as well as other services

6


delivered directly or through strategic alliances with other service providers. The products offered are aimed at both business and individual customers in our target market.
 
Loan Products
 
We have a diversified mix of business loans primarily encompassing the following loan products: (i) construction and land development loans; (ii) residential real estate loans for business investment; (iii) real estate loans for owner occupied and non-owner occupied commercial property; (iv) commercial and industrial loans and (v) SBA loans, guaranteed in part by the U.S. Government. We occasionally offer lines of credit, secured by a lien on real estate owned by our clients, which may include the primary personal residence of our clients; such lines of credit generally are requested to accommodate the business and investment needs of that customer segment. We encourage relationship banking, obtaining a substantial portion of each borrower’s banking business, including deposit accounts. We will engage in transactional based lending only for borrowers with a history of successful operations who typically have worked with our employees here or at other banks and have a good record of repayment. Although we do not typically engage in residential mortgage lending, we may acquire, from time to time, for our own investment single-family residential loans from other mortgage loan originators.
 
Construction and Land Development Loans. We originate and underwrite interim land and construction loans for commercial (including hospitality) and speculative residential purposes. Land loans are primarily to allow the borrower time to complete entitlements, or as bridge financing prior to construction. We also provide new construction and renovation loans. We do not engage in any tract construction lending. Land and construction loans are generally limited to experienced and financially supportive sponsorship, known to management, and in markets that support the development. We impose limits on the loan amount for land, acquisition and construction loans based on loan-to-cost ratios and loan-to-value ratios based on an "as completed appraisal." The project financed must be supported by current appraisals and other relevant information. These loans are typically Prime-based and have maturities of less than 36 months. Our loan-to-cost policy limits are typically 70% or less and loan-to-value limits are typically 65% or less based upon an as-completed basis for construction. There were no non-performing construction and land development loans at December 31, 2019 and 2018. The following table presents the components of our construction and land development portfolio as of December 31, 2019 and 2018:
 
 
December 31, 2019
 
December 31, 2018
 
 
Amount
 
% of Total
 
Amount
 
% of Total
 
 
(dollars in thousands)
Residential construction (single family 1-4 units)
 
$
86,798

 
34.79
%
 
$
95,906

 
52.07
%
Commercial real estate construction
 
115,769

 
46.40
%
 
68,173

 
37.02
%
Land acquisition & development
 
46,937

 
18.81
%
 
20,098

 
10.91
%
Total construction and land development loans
 
$
249,504

 
100.00
%
 
$
184,177

 
100.00
%
 
Real Estate Loans - Residential. From time to time, we purchase residential real estate loans within our market place that have been originated by unaffiliated third parties. We take a comprehensive and conservative approach to mortgage underwriting. These loans are carefully selected and audited by third parties for compliance with all applicable mortgage regulations. The typical loan is a five-year hybrid adjustable mortgage with an initial rate in the range of 4% to 7%, which re-prices after five years to the one-year LIBOR plus a specified margin. As of December 31, 2019, our residential real estate portfolio had an average loan-to-value of the portfolio of 50%. At December 31, 2019 and 2018, we had $43.7 million and $57.4 million of single-family residential real estate loans, representing 3.2% and 4.6% of our total loans held for investment. There were no non-performing single-family residential real estate loans as of December 31, 2019 and 2018.
 
Commercial Real Estate Loans. We originate and underwrite commercial property and occasionally multi-family loans, principally within our service areas. These loans are originated by both owner-users and investors. Typically, these loans are held in our loan portfolio and collateralized by the underlying property. The property financed must be supported by current appraisals at the date of origination and other relevant information, and the loan underwriting is managed with a loan-to-value policy limit between 65% and 75% and an in-house guidance limit of 65%, and minimum debt service ratio of 1.25 times debt services. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as office buildings, warehouses and production facilities, hospitality properties (such as hotels and motels), mixed-use residential and commercial, retail, commercial land and multi-family properties.
 
At December 31, 2019 and 2018, CRE loans totaled $595.4 million and $581.2 million, representing 43.3% and 46.5% of our total loans held for investment. This includes $423.8 million and $401.7 million of CRE loans secured by non-owner occupied properties and $171.6 million and $179.5 million of CRE loans secured by owner occupied properties at December 31, 2019 and 2018. Non-performing CRE loans totaled $4.4 million, or 0.74% of total CRE loans at December 31, 2019. There were no non-performing CRE loans at December 31, 2018.

7



Commercial and Industrial Loans. Our commercial and industrial loans are generally made to businesses located in the Southern California region and surrounding communities whose borrowing needs are generally $10.0 million or less. These loans may be secured by a deed of trust on real estate or secured by a perfected commercial lien on non-real estate assets, such as accounts receivable and inventory or operating equipment. The loans may be revolving lines of credit, term equipment financing, amortizing or interest only, or lines of credit secured by general liens on accounts receivable, inventory or a borrower’s other business assets, which may include loans made to third parties.

At December 31, 2019 and 2018, commercial and industrial loans amounted to $309.0 million and $281.7 million, representing 22.5% and 22.5% of our total loans held for investment. We have non-performing C&I loans of $229 thousand and $89 thousand, which represented 0.07% and 0.03% of total C&I loans, as of December 31, 2019 and 2018.
 
We also make loans that provide funding for executive retirement benefit programs. These loans are frequently secured by at least 90% and often well above that level by cash equivalent collateral, typically the cash surrender value, also known as CSV, of one or more life insurance policies. We manage these loans individually against our current house limit of $15 million and legal lending limit of 15% of total risk-based capital. Credit quality and concentration of insurer of pledged policies are monitored. The amount of the acceptable loan to CSV is dependent upon the credit quality of the insurer. A decline in the credit quality of the insurer would require the borrower to pledge additional collateral or substitute the CSV of one insurer for another or reduce the loan principal balance. At December 31, 2019 and 2018, these loans totaled $49.7 million and $36.8 million and the ratio of aggregate unpaid principal balance to aggregate CSV for this portfolio was 99.4% and 98.3%.
 
Small Business Administration (SBA) Loans. We are designated as a Preferred Lender under the SBA Preferred Lender Program. We have both a SBA 7(a) loan program, generally at variable rates, and a SBA 504 loan program, generally with an initial fixed rate term of 5 to 7 years. We originate SBA 7(a) loans with the intention of selling the guaranteed portions as soon as the loan is fully funded and the guaranteed portion may be sold. The SBA 7(a) program provides up to a 75% guaranty for loans greater than $150,000, an 85% guaranty for loans $150,000 or less, and, in certain circumstances, up to a 90% guaranty. The maximum SBA 7(a) loan amount is $5 million. The guaranty is conditional and covers a portion of the risk of payment default by the borrower, but not the risk of improper closing and servicing by the lender. The SBA 504 program is not guaranteed by the SBA (there is a junior lien loan that is guaranteed by the SBA and funded separately by the SBA). The SBA 504 program consists of real estate backed commercial mortgages where we have the first mortgage and the SBA has the second mortgage on the property. Generally, we have a less than 50% loan-to-value ratio on SBA 504 program loans at origination date. Our SBA loans are typically made to small-sized manufacturing companies, wholesalers and retailers, hotels/motels, restaurants and other service businesses for the purpose of purchasing real estate, refinancing real estate, and meeting working capital or business expansion needs. SBA loans can have any maturity up to 25 years. Typically, non-real estate secured loans mature in 10 years or less. In addition to real estate, collateral may also include inventory, accounts receivable and equipment. SBA loans are personally guaranteed. We generally sell the guaranteed portion of the SBA 7(a) loans and often the senior lien portion of SBA 504 loans in the secondary market and, for certain loans, retain the servicing responsibility. Consideration for the sale includes the cash received as well as the related servicing asset. We receive servicing fees ranging from 0.25% to 1.00% for the services provided. The portions of the SBA 7(a) loans not sold but collateralized by real estate are monitored by collateral type and included in our CRE stress testing, as separately discussed. The following table presents the components of our SBA portfolio by program at December 31, 2019 and 2018:
 
 
December 31, 2019
 
December 31, 2018
 
 
Amount
 
% of Total
 
Amount
 
% of Total
 
 
(dollars in thousands)
SBA 7(a)
 
$
100,103

 
56.35
%
 
$
100,159

 
68.39
%
SBA 504
 
77,530

 
43.65
%
 
46,303

 
31.61
%
Total SBA loans
 
$
177,633

 
100.00
%
 
$
146,462

 
100.00
%

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The following table summarizes the amount of guaranteed and unguaranteed SBA loans in the portfolio, and the collateral categories for the unguaranteed portion of SBA loans as of the dates indicated:
 
December 31,
2019
 
December 31,
2018
 
(dollars in thousands)
Secured - industrial warehouse
$
23,364

 
$
31,585

Secured - hospitality
24,858

 
22,665

Secured - retail center/building
28,182

 
5,082

Secured - other real estate
58,757

 
41,953

Unsecured or secured by other business assets
11,921

 
14,961

Total unguaranteed portion
147,082

 
116,246

Guaranteed portion
30,551

 
30,216

Total
$
177,633

 
$
146,462

    
Non-performing SBA loans totaled $6.6 million and $1.6 million, which represented 3.73% and 1.11% of total SBA loans, at December 31, 2019 and 2018.

Deposit Products
 
As a full-service commercial bank, we focus deposit generation on transactional accounts, encompassing noninterest-bearing demand, interest-bearing demand, and money market accounts. We also offer time certificates of deposit and savings accounts. We market deposits by offering the convenience of state of the art “online banking,” “remote deposit capture” products, and mobile banking technology, which allows checks to be deposited from a mobile device. We also offer customers “e-statements” which allows customers to receive statements electronically, which is more convenient and secure, in addition to reducing paper and being environmentally-friendly. To assist in our marketing efforts, we hire seasoned business development officers and focus on generating noninterest-bearing demand deposits.

Our ability to gather deposits, particularly low-cost core deposits, is an important aspect of our business franchise and a significant driver of franchise value as a cost efficient and stable source of funding to support our growth. We understand that local branding and customer loyalty are essential for business success. We have successfully generated non-maturity deposits to individual and business customers in our market area to reduce our reliance on time deposits. At December 31, 2019, we had total deposits of $1.31 billion, including noninterest-bearing demand deposits of $626.6 million, or 47.7% of total deposits. This compares to $1.25 billion of total deposits, including $546.7 million of noninterest-bearing demand deposits, or 43.7% of total deposits, at December 31, 2018. Our total deposit cost for the year ended December 31, 2019 was 0.81% compared to 0.82% for the year ended December 31, 2018.

As of December 31, 2019, our 10 largest deposit relationships totaled $370.9 million, or 28.2% of total deposits; this compares to $315.5 million, or 25.2% of total deposits, at December 31, 2018. In addition, we have 88 deposit relationships with aggregate balances over $2 million, including our 10 largest depositors, which total $770.9 million, representing 59% of total deposits at December 31, 2019.
   
For customers requiring full FDIC insurance on certificates of deposit in excess of $250,000, we occasionally offer the CDARS® program which allows us to place the time certificates of deposit with other participating banks to maximize the customers’ FDIC insurance. In December 2018, the FDIC issued a final rule, indicating that under Section 202 of the Economic Growth, Regulatory Relief, and Consumer Protection Act, well-capitalized and well-rated institutions are not required to treat reciprocal deposits as brokered deposits up to the lesser of 20% of its total liabilities or $5 billion. As of December 31, 2019, our reciprocal CDARS® deposits totaled $26.3 million, representing 1.8% of total liabilities.

In addition to the CDARS® program, we began offering deposits through Demand Deposit MarketplaceSM ("DDM") in 2019. Through this DDM deposit network, we may accept noninterest-bearing or interest-bearing deposits in excess of the FDIC insured maximum from a customer. The deposits are processed through the DDM deposit network into other member banks in increments of less than the FDIC insured maximum in order to provide the depositor full FDIC insurance coverage. We receive an equal dollar amount of deposits ("reciprocal deposits") from other DDM member banks in exchange for the deposits we place into the DDM network. These reciprocal deposits are considered non-brokered deposits and recorded as interest checking deposits in the consolidated balance sheets at December 31, 2019. The DDM reciprocal deposits totaled $22.9 million at December 31, 2019.


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Well-capitalized institutions are not subject to limitations on brokered deposits. Generally, we limit the use of brokered deposits to long-term (maturity dates in excess of one year at the time of placement) and callable deposits. Because the deposits pay a fixed interest rate for a longer period of time, they provide us with protection against increasing deposit costs as a result of rising interest rates. Furthermore, because the deposits can be called by us, they also provide us with the ability to decrease deposit cost if there is a fall in the market interest rates. During 2019, we also participated as a member of the Insured Cash Sweep ("ICS") deposit program. Through this ICS deposit program, we have the ability to place deposits through the networks for which we receive no matching deposits ("one-way" deposits). These one-way ICS deposits are considered brokered deposits and recorded as interest-bearing non-maturity deposits in the consolidated balance sheets. Brokered non-maturity deposits may be used based on market conditions and other considerations, for example, when the cost of such funds is lower than other wholesale funding sources. Total brokered non-maturity deposits at December 31, 2019 and 2018 were $48.1 million and $21.6 million, representing 3.7% and 1.7% of total deposits. Total brokered time deposits as of December 31, 2019 and 2018 were $50.4 million and $53.4 million, representing 3.8% and 4.3% of total deposits.
 
With an outstanding rating under the Community Reinvestment Act ("CRA"), we are qualified to participate in the Time Deposit Program administered by the California State Treasurer. By accessing these stable funds through the Time Deposit Program, we can provide financial services and lending products to local businesses in the communities we serve to stimulate local economies. At December 31, 2019, time deposits from the State of California totaled $25.1 million. Such deposits are included in our aforementioned 10 largest deposits. In connection with our participation in this program, the Bank purchased $27.5 million in letters of credit issued by FHLB as collateral at December 31, 2019.

Treasury Management Services. Treasury Management products play an integral role in growing our deposit base to provide our customers the tools to bank efficiently and conveniently. Treasury Management products and services are a critical component in attracting complex business and specialty deposit customers. This is especially important for customers such as 1031 Exchange companies, property management companies, developers, attorneys, accountants, manufacturers and real estate contractors that have specialized deposit service needs. Treasury Management has four basic functions: deposit handling, funds concentration, funds disbursement and information reporting. The Treasury Management services we offer include automatic transfer (sweep) of funds between accounts, automated clearing house services (e.g., ACH origination, direct deposit, direct debit and electronic cash concentration and disbursement), commercial cash vault services, lockbox, zero balance accounts, current and prior day transaction reporting, bank statement retrieval, reconciliation services, fraud prevention tools and account analysis. We emphasize responsive, courteous customer service and we send fully-trained staff to our customers’ businesses to set-up their services, so they may fully benefit from the Treasury Management services we offer.

Online Banking. We are committed to technology and e-commerce in its broadest terms and as it directly applies to financial service providers. To best serve our customers’ needs, we offer complete banking services online. Although our customers are always able to discuss specific banking needs with a knowledgeable service representative available in our offices, we offer our customers the option to conduct banking activities from our secure website – www.firstchoicebankca.com. Our website is designed to be user-friendly and to expedite customer transactions. There are multiple types of online banking services for consumers, as well as small business and commercial customers. All online banking systems allow our customers the ability to conveniently access their accounts 7-days-a-week, 24-hours-a-day to obtain account information and complete many common transactions including electronic bill pay, data download, transfer funds, reorder checks, view images of the front and back of canceled checks, view deposits, view account statements and issue stop payment requests. The commercial online banking product provides additional Treasury Management features, which allow customers to set up varied levels of security and assign access to a number of employees, with different levels of access/security for each person. Commercial online customers can view their accounts online, transfer funds from one of their accounts to another, place stop payments, initiate wire transfers, initiate Automated Clearing House (“ACH”) debits and credits, pay state and federal taxes electronically, export information to Quicken®, QuickBooks®, or Excel Spreadsheets and utilize robust reporting tool features. We also offer ACH and Check Positive Pay antifraud services which allows a business to review their ACH debit transactions and/or all of their issued checks daily and then provides them with the ability to pay or reject any item.

We are sensitive to the privacy and security concerns of our customers, especially where internet banking is concerned. Accordingly, we have various procedures designed to maintain appropriate security levels. The vendors who support our internet banking platform work with us to enhance the security of these services. Our responsibility to our customers is to select appropriate hardware and software to provide the best assurance we can to our customers that, subject to applicable law, we can protect their privacy and finances.
 
Mobile Banking. We offer mobile banking service to consumer and business customers. The mobile banking applications allow customers to access their account information, make transfers, deposit checks, manage their debit card security and pay bills while on the go and from the convenience of their registered mobile device.

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 Remote Deposit. For the convenience of and to better serve our customers, we offer qualified commercial customers a state-of-the-art remote deposit capture (“RDC”) product that allows businesses to process check deposits on a daily basis from the convenience of their location. At December 31, 2019, we had approximately 238 customers utilizing RDC.

Specialty Deposit Group. The Specialty Deposit Group was established to focus on banking large complex business customers. The dedicated service team manages new and existing specialty relationships and provides ongoing analysis, monitoring and support. Targeted specialty niches, include but are not limited to, escrow companies, 1031 Exchange accommodators, contractor retention escrows, and property management companies.
 
Other Services. In addition to a full complement of lending and deposit products and related services, we provide customers, through other providers, access to Automated Teller Machines (“ATM’s”) using their Visa® EMV Debit Cards; bank-by-mail, courier services, domestic and international wires, credit cards and documentary collection. We reimburse customers for surcharges for any transactions conducted on another bank’s ATM’s.

Market Area and Competition
 
Our primary market area includes the seven Southern California Counties, composed of Los Angeles, Orange, San Diego, Ventura, Riverside, San Bernardino and Imperial. The economic base of the area is heavily dependent on small- and medium-sized businesses. Our relationship management team consists of experienced bankers involved with the business communities in their market areas. Their business development efforts are augmented by referrals from our Board of Directors and existing customers. The members of our management team, in particular, are well experienced in business lending, supporting middle-market banking needs, and generating value-added banking services to small- and medium-sized businesses.
 
The banking business in California is highly competitive with respect to both loans and deposits and is dominated by a relatively small number of major financial institutions with many offices operating over a wide geographic area, including institutions based outside of California. The increasingly competitive environment faced by banks is a result primarily of changes in laws and regulations, changes in technology and product delivery systems, the accelerating pace of consolidation among financial services providers and the emergence of non-regulated financial technology companies. We compete for loans and deposits with other commercial banks, as well as with finance companies, credit unions, securities and brokerage companies, money market funds and other non-financial institutions. Larger financial institutions offer certain services (such as trust services or wealth management) that we do not offer. These institutions also have the ability to finance extensive advertising campaigns. By virtue of their greater total capitalization, such institutions also have substantially higher lending limits than we have.
 
Our ability to compete is based primarily on our ability to develop a relationship, built upon customer service and responsiveness to customer needs. Our “preferred lender” status with the Small Business Administration allows us to approve SBA loans faster than many of our competitors. We distinguish ourselves with the availability and accessibility of our senior management to customers and prospects. In addition, our knowledge of our markets and industries assists us in locating, recruiting and retaining customers. Our ability to compete also depends on our ability to continue to attract and retain our senior management and experienced relationship managers.
 
Implications of Being an Emerging Growth Company
 
We are an “emerging growth company” as defined in Section 2(a)(19) of the Securities Act, as modified by the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). An emerging growth company may take advantage of reduced reporting requirements and is relieved of certain other significant requirements that are otherwise generally applicable to public companies. As an emerging growth company:
 
we may present as few as two years of audited consolidated financial statements and two years of related management discussion and analysis of financial condition and results of operations;

we are exempt from the requirement to obtain an attestation and report from our auditors on management’s assessment of our internal control over financial reporting under the Sarbanes-Oxley Act of 2002;

we are permitted to provide less extensive disclosure about our executive compensation arrangements; and

we are not required to give our shareholders non-binding advisory votes on executive compensation or golden parachute arrangements.

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We have elected to take advantage of the reduced disclosure requirements relating to executive compensation and the number of years of financial information presented, and in the future we may take advantage of any or all of these exemptions for so long as we remain an emerging growth company. We will remain an emerging growth company until the earliest of (i) the end of the fiscal year during which we have total annual gross revenues of $1.0 billion or more, (ii) the end of the fiscal year following the fifth anniversary of the completion of our initial public offering which would be December 31, 2023, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt, and (iv) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934.
 
In addition to the relief described above, the JOBS Act provided an optional extended transition period for complying with new or revised accounting standards affecting public companies. We have irrevocably opted to decline this extended transition period, which means that the consolidated financial statements included in this Annual Report on Form 10-K, as well as any consolidated financial statements that we file in the future, will be subject to all new or revised accounting standards generally applicable to public companies.

Environmental, Social and Governance (“ESG”) Practices

We are committed to excellence in our environmental, social and governance practices, with our Compensation, Nominating and Corporate Governance Committee (“CNGC”) assuming primary oversight of our efforts in ESG matters. As a result of these efforts we have been recognized on the American Banker’s Best Banks to Work For list for two consecutive years, have been showcased in the California Bankers Association social impact awareness campaign for our community service mission, and have been awarded the annual Bank Enterprise Award since 2011 by the U.S. Department of the Treasury’s Community Development Financial Institution (“CDFI”) Fund. We have received ten consecutive Business Enterprise Awards totaling an aggregate of $3.0 million, of which one award was granted to PCB prior to its acquisition date in 2018, from the CDFI Fund for our continuing efforts to increase the lending and service activities within the economically distressed communities that we serve. In addition, we received the highest available rating, “Outstanding,” during our most recent Community Reinvestment Act (“CRA”) examination by the Federal Reserve, our primary federal banking regulator. The CRA examination reviewed the Bank’s achievements in meeting the credit needs of the communities in which we operate, including low- and moderate- income (“LMI”) neighborhoods and, according to the Federal Reserve, our Bank’s geographic distribution of loans reflected excellent dispersion throughout low‐ and moderate- income census tracts within our assessment areas. The Bank’s performance under the community development test was “outstanding” and demonstrated excellent responsiveness to the community development needs of our assessment areas; and we engaged in a significant volume of community development loans, investments, and services relative to our capacity and the need and availability of such opportunities in our assessment areas.
    
As a qualified minority depository institution (“MDI”), a majority of our Board of Directors are ethnic minorities and the communities we serve are comprised predominantly of ethnic minorities. In addition to this certification, a majority of our active employees are ethnic minorities, with approximately 35% identifying as Asian and 32% identifying as Hispanic at December 31, 2019. In terms of gender diversity, approximately 65% of our workforce identify as women and who also compose approximately 43% of our executive management team. Finally, not only do we strive to contribute to global efforts to achieve environmental sustainability through workplace programs, we also promote a SBA 504 green loan program which provides financing to small businesses looking to grow and expand their operations through the purchase of commercial real estate and to “go green” by replacing existing facilities or retrofitting existing facilities to include technologies that reduce energy consumption or upgrading existing equipment and processes to utilize renewable energy sources (solar, wind, turbine, thermal) or renewable fuel producers, including biodiesel and ethanol producers.

Employees

At December 31, 2019, we had 181 full time equivalent (“FTE”) employees. None of our employees are represented by collective bargaining agreements.

Available Information
 
We invite you to visit our website at www.firstchoicebankca.com via the “Investor Relations” link, to access free of charge the Company's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, all of which are made available as soon as reasonably practicable after we electronically file such material with or furnish it to the SEC. The content of our website is not incorporated into and is not part of this Annual Report on Form 10-K. In addition, you can write to us to obtain a free copy of any of those reports at First Choice Bancorp, 17785 Center Court Drive N., Suite 750, Cerritos, CA 90703, Attn: Investor Relations. These reports are also available through the SEC's Public Reference Room, located at 100 F Street NE, Washington, DC 20549 and online at the SEC’s

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website, located at www.sec.gov. The public can obtain information about the operation of the Public Reference Room by calling the SEC at 800-SEC-0330.

Regulation and Supervision

Banks and bank holding companies are heavily regulated by federal and state laws and regulations.  Most banking regulations are intended primarily for the protection of depositors and the deposit insurance fund and not for the benefit of shareholders.  

The following is a summary of certain statutes, regulations and regulatory guidance affecting the holding company and the Bank.  This summary is not intended to be a complete explanation of such statutes, regulations and guidance, all of which are subject to change in the future, nor does it fully address their effects and potential effects on the Company and the Bank.

Regulation of the Holding Company Generally

The holding company is a legal entity separate and distinct from the Bank. As a bank holding company, it is regulated under the Bank Holding Company Act of 1956 (the “BHC Act”) and, therefore, is subject to supervision, regulation and inspection by the Federal Reserve. The holding company is also subject to certain provisions of the California Financial Code which are applicable to bank holding companies. In addition, because the holding company’s common stock is registered with the Securities and Exchange Commission, or SEC, it is subject to the SEC’s disclosure and periodic filing requirements as promulgated by the SEC under the Securities Act of 1933 and the Securities Exchange Act of 1934. Our common stock is listed on the NASDAQ under the trading symbol “FCBP” and, accordingly, we are subject to the rules of NASDAQ for listed companies.

The holding company is required to file annual reports and other information with the Federal Reserve regarding its business operations and those of its subsidiaries. In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve has determined to be so closely related to banking as to be a proper incident thereto, including securities brokerage services, investment advisory services, fiduciary services, and management advisory and data processing services, among others.

The BHC Act requires the prior approval of the Federal Reserve for the direct or indirect acquisition of more than 5% of the voting shares of a commercial bank or its parent holding company. Acquisitions by the Bank are subject instead to the Bank Merger Act, which requires the prior approval of an acquiring bank’s primary federal regulator for any merger with or acquisition of another bank. Acquisitions by both the holding company and the Bank also require the prior approval of the DBO pursuant to the California Financial Code.

The holding company and the Bank are deemed to be “affiliates” of each other and thus are subject to Sections 23A and 23B of the Federal Reserve Act as well as related Federal Reserve Regulation W which impose both quantitative and qualitative restrictions and limitations on transactions between affiliates. The Bank is also subject to laws and regulations requiring that all extensions of credit to our executive officers, directors, principal shareholders and related parties must, among other things, be made on substantially the same terms and follow credit underwriting procedures no less stringent than those prevailing at the time for comparable transactions with persons not related to the Bank.

A bank holding company is required to act as a source of financial and managerial strength for its subsidiary banks and must commit resources as necessary to support such subsidiaries. Under certain conditions, the Federal Reserve has the authority to restrict the payment of cash dividends by a bank holding company as an unsafe and unsound banking practice and may require a bank holding company to obtain the approval of the Federal Reserve prior to purchasing or redeeming its own equity securities. The Federal Reserve may require a bank holding company to contribute additional capital to an undercapitalized subsidiary bank and may disapprove of the holding company’s payment of dividends to the shareholders in such circumstances. The Federal Reserve also has the authority to regulate the debt of bank holding companies.

The holding company meets the eligibility criteria of a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy Statement (Regulation Y, Appendix C) (the “Policy Statement”) and, therefore is not subject to consolidated capital rules at the bank holding company level. On May 24, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Relief Act”) was signed into law. Among the Relief Act's key provisions are targeted tailoring measures to reduce the regulatory burden on community banks, including increasing the threshold for institutions qualifying for relief under the Policy Statement to bank holding companies with total consolidated assets of less than $3 billion (up from the prior $1 billion threshold). Under the Policy Statement, qualifying bank holding companies, such as First Choice Bancorp, have additional flexibility in the amount of debt they can issue and are also exempt

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from the Basel III Capital Rules. The Policy Statement does not apply to the Bank and the Bank must comply with the Basel III Capital Rules. The Bank must also comply with the capital requirements set forth in the Prompt Corrective Action Provisions regulations as described below.

Sarbanes-Oxley Act of 2002. The Company is subject to the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) which addresses, among other issues, (i) corporate governance and disclosure issues, including the controls and procedures and internal control over financial reporting, (ii) certification of financial statements by the chief executive officer and the chief financial officer, (iii) auditing and accounting, (iv) forfeiture of bonuses and profits made by directors and senior officers in the 12-month period covered by restated financial statements, (v) a prohibition on insider trading during black-out periods, (vi) disclosure of off-balance sheet transactions, and (vii) accelerated share transaction filing requirements for officers and directors. In addition, Sarbanes-Oxley increased penalties for non-compliance with the Exchange Act of 1934. SEC rules, promulgated pursuant to Sarbanes-Oxley, impose obligations and restrictions on auditors and audit committees with the intention of enhancing their independence from management, and include extensive additional disclosure, corporate governance and other related rules.

Regulation of the Bank Generally

As a state-chartered member bank, the Bank is subject to broad federal regulation and oversight extending to all its operations by the Federal Reserve and to state regulation by the DBO.

Capital Adequacy Requirements. The Bank is subject to the regulations of the Federal Reserve governing capital adequacy. This agency has adopted risk-based capital guidelines to provide a systematic analytical framework that imposes regulatory capital requirements based on differences in risk profiles among banking organizations, considers off-balance sheet exposures in evaluating capital adequacy, and minimizes disincentives to holding liquid, low-risk assets. Capital levels, as measured by these standards, are also used to categorize financial institutions for purposes of certain prompt corrective action regulatory provisions.

Pursuant to the adoption of final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for all U.S. banks and bank holding companies with more than $500 million in assets, minimum regulatory requirements for both the quantity and quality of capital held by the holding company and the Bank increased effective January 1, 2015. Furthermore, a capital class known as Common Equity Tier 1 (“CET1”) capital was established in addition to Tier 1 capital and Tier 2 capital, and most financial institutions were given the option of a one-time election to continue to exclude accumulated other comprehensive income (“AOCI”) from regulatory capital. We have exercised our option to exclude AOCI from regulatory capital. The final rules also increased capital requirements for certain categories of assets, including higher-risk construction and real estate loans, certain past-due or nonaccrual loans, and certain exposures related to securitizations. The final rules permanently grandfather non-qualifying capital instruments (such as trust preferred securities and cumulative perpetual preferred stock) issued before May 19, 2010 for inclusion in the Tier 1 capital of banking organizations with total consolidated assets of less than $15 billion at December 31, 2009, subject to a limit of 25% of Tier 1 capital.

Common Equity Tier 1, or CET1, capital includes common stock, additional paid-in capital, and retained earnings, less the following: disallowed goodwill and intangibles, disallowed deferred tax assets, and any insufficient additional capital to cover the deductions. Tier 1 capital is generally defined as the sum of core capital elements, less the following: goodwill and other intangible assets, accumulated other comprehensive income, disallowed deferred tax assets, and certain other deductions. The following items are defined as core capital elements: (i) common shareholders’ equity; (ii) qualifying non-cumulative perpetual preferred stock and related surplus (and, in the case of holding companies, senior perpetual preferred stock issued to the U.S. Treasury Department pursuant to the Troubled Asset Relief Program); (iii) minority interests in the equity accounts of consolidated subsidiaries; and (iv) “restricted” core capital elements (which include qualifying trust preferred securities) up to 25% of all core capital elements. Tier 2 capital includes the following supplemental capital elements: (i) allowance for loan and lease losses (but not more than 1.25% of an institution’s risk-weighted assets); (ii) perpetual preferred stock and related surplus not qualifying as core capital; (iii) hybrid capital instruments, perpetual debt and mandatory convertible debt instruments; and, (iv) term subordinated debt and intermediate-term preferred stock and related surplus. The maximum amount of Tier 2 capital is capped at 100% of Tier 1 capital.

The final rules established a regulatory minimum of 4.5% for common equity Tier 1 capital to total risk weighted assets (“Common Equity Tier 1 RBC Ratio”), a minimum of 6.0% for Tier 1 capital to total risk weighted assets (“Tier 1 Risk-Based Capital Ratio” or “Tier 1 RBC Ratio”), a minimum of 8.0% for qualifying Tier 1 plus Tier 2 capital to total risk weighted assets (“Total Risk-Based Capital Ratio” or “Total RBC Ratio”), and a minimum of 4.0% for the Leverage Ratio, which is defined as Tier 1 capital to adjusted average assets (quarterly average assets less the disallowed capital items discussed above). In addition to the other minimum risk-based capital standards the final rules also require a Common

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Equity Tier 1 capital conservation buffer, which has been phased in over three years starting on January 1, 2016. The capital conservation buffer was 0.625% for 2016, 1.25% for 2017, 1.875% for 2018 and has been fully phased in to 2.5% of risk-weighted assets beginning on January 1, 2019. The buffer has effectively raised the minimum required Common Equity Tier 1 RBC Ratio to 7.0%, the Tier 1 RBC Ratio to 8.5%, and the Total RBC Ratio to 10.5%. Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases, and on the payment of discretionary bonuses to executive management.

Based on our capital levels at December 31, 2019 and 2018, the Bank met all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis.  For more information on the Bank's capital, please refer to Part II, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.  Risk-based capital ratio (“RBC”) requirements are discussed in greater detail in the following section.

Prompt Corrective Action Provisions. Federal law requires each federal banking agency to take prompt corrective action to resolve the problems of insured financial institutions, including but not limited to those that fall below one or more of the prescribed minimum capital ratios. The federal banking agencies have by regulation defined the following five capital categories: “well capitalized” (Total RBC Ratio of 10%; Tier 1 RBC Ratio of 8%; Common Equity Tier 1 RBC Ratio of 6.5%; and Leverage Ratio of 5%); “adequately capitalized” (Total RBC Ratio of 8%; Tier 1 RBC Ratio of 6%; Common Equity Tier 1 RBC Ratio of 4.5%; and Leverage Ratio of 4%); “undercapitalized” (Total RBC Ratio of less than 8%; Tier 1 RBC Ratio of less than 6%; Common Equity Tier 1 RBC Ratio of less than 4.5%; or Leverage Ratio of less than 4%); “significantly undercapitalized” (Total RBC Ratio of less than 6%; Tier 1 RBC Ratio of less than 4%; Common Equity Tier 1 RBC Ratio of less than 3%; or Leverage Ratio less than 3%); and “critically undercapitalized” (tangible equity to total assets less than or equal to 2%). A bank may be treated as though it were in the next lower capital category if, after notice and the opportunity for a hearing, the appropriate federal agency finds an unsafe or unsound condition or practice merits a downgrade, but no bank may be treated as “critically undercapitalized” unless its actual tangible equity to assets ratio warrants such treatment. As of December 31, 2019 and 2018, the Bank was deemed to be well capitalized for regulatory capital purposes.
    
At each successively lower capital category, an insured bank is subject to increased restrictions on its operations. For example, a bank is generally prohibited from paying management fees to any controlling persons or from making capital distributions if to do so would cause the bank to be “undercapitalized.” Asset growth and branching restrictions apply to undercapitalized banks, which are required to submit written capital restoration plans meeting specified requirements (including a guarantee by the parent holding company, if any). “Significantly undercapitalized” banks are subject to broad regulatory authority, including among other things capital directives, forced mergers, restrictions on the rates of interest they may pay on deposits, restrictions on asset growth and activities, and prohibitions on paying bonuses or increasing compensation to senior executive officers without FDIC approval. Even more severe restrictions apply to “critically undercapitalized” banks. Most importantly, except under limited circumstances, not later than 90 days after an insured bank becomes critically undercapitalized the appropriate federal banking agency is required to appoint a conservator or receiver for the bank.

In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential actions by the federal regulators for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the issuance of cease and desist orders, termination of insurance on deposits (in the case of a bank), the imposition of civil money penalties, the issuance of directives to increase capital, formal and informal agreements, or removal and prohibition orders against “institution-affiliated” parties.
    
Community Bank Capital Simplification - Community Bank Leverage Ratio. Community banks have long raised concerns with bank regulators about the regulatory burden, complexity, and costs associated with certain provisions of the Basel III Rule. In response, Congress provided a potential Basel III “off-ramp” for institutions, like us, with total consolidated assets of less than $10 billion. Section 201 of the Regulatory Relief Act instructed the federal banking regulators to establish a single “Community Bank Leverage Ratio” (“CBLR”) of between 8% and 10%. On September 17, 2019, the federal banking regulatory agencies finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the CBLR framework). The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a Tier 1 leverage ratio of greater than 9.0%, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report

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or calculate risk-based capital. The CBLR framework will be available for banks to use in their March 31, 2020, Call Report. We plan to opt into the CBLR framework.

Safety and Soundness Standards. The federal banking agencies have also adopted guidelines establishing safety and soundness standards for all insured depository institutions. Those guidelines relate to internal controls, information systems, internal audit systems, loan underwriting and documentation, compensation, and liquidity and interest rate exposure. In general, the standards are designed to assist the federal banking agencies in identifying and addressing problems at insured depository institutions before capital becomes impaired. If an institution fails to meet the requisite standards, the appropriate federal banking agency may require the institution to submit a compliance plan and could institute enforcement proceedings if an acceptable compliance plan is not submitted or followed.

The Dodd-Frank Wall Street Reform and Consumer Protection Act. Legislation and regulations enacted and implemented since 2008 in response to the U.S. economic downturn and financial industry instability continue to impact most institutions in the banking sector. Certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which was enacted in 2010, are now effective and have been fully implemented, including revisions to the deposit insurance assessment base for FDIC insurance and a permanent increase in coverage to $250,000; the permissibility of paying interest on business checking accounts; the removal of barriers to interstate branching; and, required disclosures and shareholder advisory votes on executive compensation. Additional actions taken to implement Dodd-Frank provisions include (i) final capital rules, (ii) a final rule to implement the so-called Volcker rule restrictions on certain proprietary trading and investment activities, and (iii) final rules and increased enforcement action by the Consumer Finance Protection Bureau (discussed further below in connection with consumer protection).

Some aspects of Dodd-Frank are still subject to rulemaking, making it difficult to anticipate the ultimate financial impact on the Company, its customers or the financial services industry more generally. However, many provisions of Dodd-Frank are already affecting our operations and expenses, including but not limited to changes in FDIC assessments, the permitted payment of interest on demand deposits, and enhanced compliance requirements. Some of the rules and regulations promulgated or yet to be promulgated under Dodd-Frank will apply directly only to institutions much larger than ours, but could indirectly impact smaller banks, either due to competitive influences or because certain required practices for larger institutions may subsequently become expected “best practices” for smaller institutions. We could see continued attention and resources devoted by the Company to ensure compliance with the statutory and regulatory requirements engendered by Dodd-Frank.

In reaction to the global financial crisis and particularly following the passage of the Dodd Frank Act, the Company experienced heightened regulatory requirements and scrutiny. Although the reforms primarily targeted systemically important financial service providers, their influence filtered down in varying degrees to community banks over time and caused the Company’s compliance and risk management processes, and the costs thereof, to increase. After the 2016 federal elections, momentum to decrease the regulatory burden on community banks gathered strength. In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Regulatory Relief Act”) was enacted to modify or remove certain financial reform rules and regulations. While the Regulatory Relief Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion, like the Company, and for large banks with assets of more than $50 billion. Many of these changes are intended to result in meaningful regulatory relief for community banks and their holding companies, including new rules that may make the capital requirements less complex. For a discussion of capital requirements, please refer to “-Capital Adequacy Requirements.” It also eliminated questions about the applicability of certain Dodd-Frank Act reforms to community bank systems, including relieving the Bank of any requirement to engage in mandatory stress tests or comply with the Volcker Rule’s complicated prohibitions on proprietary trading and ownership of private funds. We believe these reforms are favorable to our operations, but the true impact remains difficult to predict until rulemaking is complete and the reforms are fully implemented.
 
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured institutions pay insurance premiums at rates based on their risk classification. For institutions like the Bank that are not considered large and highly complex banking organizations, assessments are now based on examination ratings and financial ratios. The total base assessment rate currently ranges from 1.5 basis points to 30 basis points. The assessment base against which an FDIC-insured institution’s deposit insurance premiums paid to the DIF has been calculated since effectiveness of the Dodd-Frank Act based on its average consolidated total assets less its average tangible equity. This method shifted the burden of deposit insurance premiums toward those large depository institutions that rely on funding sources other than U.S. deposits. At least semi-annually, the FDIC updates its loss and income projections for the Deposit Insurance Fund ("DIF") and, if needed, increases or decreases the assessment rates, following notice and comment on proposed rulemaking. Our annual assessment rate was 3 basis points in 2019.

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The reserve ratio is the FDIC insurance fund balance divided by estimated insured deposits. The Dodd-Frank Act altered the minimum reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to FDIC-insured institutions when the reserve ratio exceeds certain thresholds. The FDIC provides assessment credits to insured depository institutions, like the Bank, with total consolidated assets of less than $10 billion for their portion of their regular assessments that contribute to growth in the reserve ratio between 1.15% and 1.35%. The FDIC will apply the credits each quarter that the reserve ratio is at least 1.38% to offset the regular deposit insurance assessments of institutions with credits. The reserve ratio reached 1.41% as of September 30, 2019 (most recent available), exceeding the statutory required minimum reserve ratio of 1.35%. The FDIC had estimated the assessment credits to the Bank of $352 thousand, of which $212 thousand was received in 2019. The Bank is expecting to receive the remaining assessment credit from the FDIC in 2020.

Community Reinvestment Act. The Bank is subject to certain requirements and reporting obligations involving the Community Reinvestment Act (“CRA”) activities. The CRA generally requires federal banking agencies to evaluate the record of a financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods. The CRA further requires the agencies to consider a financial institution’s efforts in meeting its community credit needs when evaluating applications for, among other things, domestic branches, mergers or acquisitions, or the formation of holding companies. In measuring a bank’s compliance with its CRA obligations, the regulators utilize a performance-based evaluation system under which CRA ratings are determined by the bank’s actual lending, service, and investment performance, rather than on the extent to which the institution conducts needs assessments, documents community outreach activities or complies with other procedural requirements. In connection with its assessment of CRA performance, the federal regulatory agencies assign a rating of “outstanding,” “satisfactory,” “needs to improve” or “substantial noncompliance.” The Bank received an “outstanding” rating in its most recent CRA evaluation in 2019.

Privacy and Data Security. The Gramm-Leach-Bliley Act, also known as the Financial Modernization Act of 1999 (the “Financial Modernization Act”), imposed requirements on financial institutions with respect to consumer privacy. Financial institutions, however, are required to comply with state law if it is more protective of consumer privacy than the Financial Modernization Act. The Financial Modernization Act generally prohibits disclosure of consumer information to non-affiliated third parties unless the consumer has been given the opportunity to object and has not objected to such disclosure. The statute also directed federal regulators, including the Federal Reserve and the FDIC, to establish standards for the security of consumer information, and requires financial institutions to disclose their privacy policies to consumers annually.

In June 2018, California adopted the California Consumer Privacy Act of 2018 (“CCPA”) which became effective January 1, 2020. The CCPA gives “consumers” (defined as natural persons who are California residents) four basic rights in relation to their personal information:

the right to know, through a general privacy policy and with more specifics available upon request, what personal information a business has collected about them, where it was sourced from, what it is being used for, whether it is being disclosed or sold, and to whom it is being disclosed or sold;

the right to “opt out” of allowing a business to sell their personal information to third parties (or, for consumers who are under 16 years old, the right not to have their personal information sold absent their, or their parent’s, opt-in);

the right to have a business delete their personal information, with some exceptions; and

the right to receive equal service and pricing from a business, even if they exercise their privacy rights under the CCPA.

The CCPA can be enforced by the California Attorney General, subject to a thirty-day cure period. The civil penalty for intentional violations of the CCPA is up to $7,500 per violation.

The CCPA also provides a private right of action that allows consumers to seek, either individually or as a class, statutory or actual damages and injunctive and other relief, if their sensitive personal information (more narrowly defined than under the rest of the CCPA) is subject to unauthorized access and exfiltration, theft or disclosure as a result of a business’s failure to implement and maintain required reasonable security procedures. Statutory damages can be between $100 and $750 per California resident per incident, or actual damages, whichever is greater.

In September 2018, California adopted amendments to the CCPA. In particular, the bill clarifies the exemption for personal information that is regulated under the Financial Modernization Act and adds an exemption for personal information

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regulated under the California Financial Information Privacy Act. These two statutes also regulate the privacy of consumer financial information.

Consumer Financial Protection and Financial Privacy. Dodd-Frank created the Consumer Finance Protection Bureau (the “CFPB”) as an independent entity with broad rulemaking, supervisory and enforcement authority over consumer financial products and services including deposit products, residential mortgages, home-equity loans and credit cards. The CFPB’s functions include investigating consumer complaints, conducting market research, rulemaking, supervising and examining bank consumer transactions, and enforcing rules related to consumer financial products and services. CFPB regulations and guidance apply to all financial institutions, including the Bank, although only banks with $10 billion or more in assets are subject to examination by the CFPB. Banks with less than $10 billion in assets, including the Bank, are examined for compliance by their primary federal banking agency.

In January 2013, the CFPB issued final regulations governing consumer mortgage lending. Certain rules which became effective in January 2014 impose additional requirements on lenders, including the directive that lenders need to ensure the ability of their borrowers to repay mortgages. The CFPB also finalized a rule on escrow accounts for higher priced mortgage loans and a rule expanding the scope of the high-cost mortgage provision in the Truth in Lending Act. The CFPB also issued final rules implementing provisions of the Dodd-Frank Act that relate to mortgage servicing. In November 2013 the CFPB issued a final rule on integrated and simplified mortgage disclosures under the Truth in Lending Act and the Real Estate Settlement Procedures Act, which became effective in October 2015.

The CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer’s: (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer’s interests.

In addition, as is the case with all financial institutions, the Bank is required to maintain the privacy of its customers’ non-public, personal information. Such privacy requirements direct financial institutions to: (i) provide notice to customers regarding privacy policies and practices; (ii) inform customers regarding the conditions under which their non-public personal information may be disclosed to non-affiliated third parties; and (iii) give customers an option to prevent disclosure of such information to non-affiliated third parties.

The Company continues to be subject to numerous other federal and state consumer protection laws that extensively govern its relationship with its customers. Those laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Service Members Civil Relief Act, and respective state-law counterparts to these laws, as well as state usury laws and laws regarding unfair and deceptive acts and practices. These and other laws require disclosures including the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, prohibit unfair, deceptive and abusive practices, and otherwise subject the holding company to substantial regulatory oversight.

Identity Theft. Under the Fair and Accurate Credit Transactions Act (the “FACT Act”), the Bank is required to develop and implement a written Identity Theft Prevention Program to detect, prevent and mitigate identity theft “red flags” in connection with certain existing accounts or the opening of certain accounts. Under the FACT Act, the Bank is required to adopt reasonable policies and procedures to (i) identify relevant red flags for covered accounts and incorporate those red flags into the program; (ii) detect red flags that have been incorporated into the program; (iii) respond appropriately to any red flags that are detected to prevent and mitigate identity theft; and (iv) ensure the program is updated periodically, to reflect changes in risks to customers or to the safety and soundness of the financial institution or creditor from identity theft. The Bank maintains a program to meet the requirements of the FACT Act and the Bank believes it is currently in compliance with these requirements.
    
Interstate Banking and Branching. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”), together with Dodd-Frank, relaxed prior interstate branching restrictions under federal law by permitting, subject to regulatory approval, state and federally chartered commercial banks to establish branches in states where the laws permit banks chartered in such states to establish branches. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area. Federal banking agency regulations prohibit banks from using their interstate branches primarily for deposit production and the federal banking

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agencies have implemented a loan-to-deposit ratio screen to ensure compliance with this prohibition. Dodd-Frank effectively eliminated the prohibition under California law against interstate branching through de novo establishment of California branches. Interstate branches are subject to certain laws of the states in which they are located. We presently do not have any interstate branches.

USA Patriot Act of 2001. The impact of the USA Patriot Act of 2001 (the “Patriot Act”) on financial institutions of all kinds has been significant and wide ranging. The Patriot Act substantially enhanced anti-money laundering and financial transparency laws and required certain regulatory authorities to adopt rules that promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. Under the Patriot Act, financial institutions are subject to prohibitions regarding specified financial transactions and account relationships, as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. The Patriot Act also requires all financial institutions to establish anti-money laundering programs. The Bank expanded its Bank Secrecy Act compliance staff and intensified due diligence procedures concerning the opening of new accounts to fulfill the anti-money laundering requirements of the Patriot Act, and also implemented systems and procedures to identify suspicious banking activity and report any such activity to the Financial Crimes Enforcement Network.

Incentive Compensation.     In June 2010, the Federal Reserve and the FDIC issued comprehensive final guidance on incentive compensation policies intended to help ensure that banking organizations do not undermine their own safety and soundness by encouraging excessive risk-taking. The guidance, which covers all employees who have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization's board of directors. The regulatory agencies will review, as part of their regular risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” Where appropriate, the regulatory agencies will take supervisory or enforcement action to address perceived deficiencies in an institution’s incentive compensation arrangements or related risk-management, control, and governance processes. We believe that we are in compliance with the regulatory guidance on incentive compensation policies.
    
Commercial Real Estate Lending Concentrations. As a part of their regulatory oversight, the federal regulators have issued guidelines on sound risk management practices with respect to a financial institution’s concentrations in CRE lending activities. These guidelines were issued in response to the agencies’ concerns that rising CRE concentrations might expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the commercial real estate market. The guidelines identify certain concentration levels that, if exceeded, will expose the institution to additional supervisory analysis with regard to the institution’s CRE concentration risk. The guidelines are designed to promote appropriate levels of capital and sound loan and risk management practices for institutions with a concentration of CRE loans. In general, the guidelines establish the following supervisory criteria as preliminary indications of possible CRE concentration risk: (1) the institution’s total construction, land development and other land loans represent 100% or more of total risk-based capital; or (2) total CRE loans as defined in the regulatory guidelines represent 300% or more of total risk-based capital, and the institution’s CRE loan portfolio has increased by 50% or more during the prior 36 month period. The Company believes that the guidelines are applicable to it, as it has a relatively high concentration in CRE loans. The Company and its Board of Directors have discussed the guidelines and believe that the Bank’s underwriting policies, management information systems, independent credit administration process, and monitoring of real estate loan concentrations are sufficient to address the guidelines.

Other Pending and Proposed Legislation

Other legislative and regulatory initiatives which could affect the Company, the Bank and the banking industry in general are pending, and additional initiatives may be proposed or introduced before the United States Congress, the California legislature and other governmental bodies in the future. Such proposals, if enacted, may further alter the structure, regulation and competitive relationship among financial institutions, and may subject the Company to increased regulation, disclosure and reporting requirements. In addition, the various banking regulatory agencies often adopt new rules and regulations to implement and enforce existing legislation. It cannot be predicted whether, or in what form, any such legislation or regulations may be enacted or the extent to which the business of the Company would be affected thereby.


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ITEM 1A. RISK FACTORS

In addition to the other information on the risks we face and our Management of risk contained in this Annual Report on Form 10-K or in our other SEC filings, the following are material risks which may affect us. Events or circumstances arising from one or more of these risks could adversely affect our business, consolidated financial condition, consolidated results of operations, and prospects-and the value and price of our common stock could decline. The risks identified below are not intended to be a comprehensive list of all risks we face, and additional risks that we may currently view as not material may also impair our consolidated financial condition and consolidated results of operations.

Readers and prospective investors in our securities should carefully consider the following risk factors as well as the other information contained or incorporated by reference in this report. This report is qualified in its entirety by these risk factors.

MARKET RISKS

Difficult economic and market conditions may adversely affect our industry.

Our financial performance, and the ability of borrowers to pay interest on, and repay the principal of, outstanding loans and the value of the collateral securing those loans is highly dependent upon the business and economic conditions in the markets in which we operate and in the United States as a whole. Economic pressures on consumers and businesses may adversely affect our business, consolidated financial condition, consolidated results of operations, and stock price. In particular, our banking operations are concentrated primarily in Southern California. Deterioration of economic conditions in Southern California could impair the ability of our borrowers to service their loans, decrease the level and duration of deposits by customers, and erode the value of loan collateral. These conditions could increase the amount of our non-performing assets and have an adverse effect on our efforts to collect our non-performing loans or otherwise liquidate our non-performing assets (including other real estate owned) on terms favorable to us, if at all. These conditions could also cause a decline in demand for our products and services, a lack of growth, or a decrease in deposits, any of which may cause us to incur losses, adversely affect our capital, and hurt our business.
The effects of widespread public health emergencies such as the outbreak of coronavirus disease 2019 ("COVID-19"), has negatively affected the U.S. economy and will likely negatively affect our local economies and may disrupt our operations, which would have an adverse effect on our business or results of operations.

Widespread health emergencies, such as the recent coronavirus disease 2019 (COVID-19) outbreak in China, U.S. and other countries, may disrupt our operations through their impact on our employees, customers and their businesses, and certain industries in which our customers operate. Disruptions to our customers may impair their ability to fulfill their obligations to the Company and result in increased risk of delinquencies, defaults, foreclosures, declining collateral values associated with our existing loans, and losses on our loans. Further, the spread of the outbreak has caused severe disruptions in the U.S. economy and may likely disrupt banking and other financial activity in the areas in which the Company operates. This would likely result in a decline in demand for our products and services, including loans and deposits which would negatively impact our liquidity position and our growth strategy. Any one or more of these developments would have a material adverse effect on our business, operations, consolidated financial condition, and consolidated results of operations.

Our business is subject to interest rate risk, and fluctuations in interest rates which could reduce our net interest income and adversely affect our business.

The Federal Reserve lowered the federal funds target rate three times in 2019 and increased the federal funds target rate four times in 2018. A substantial portion of our income is derived from the differential, or “spread,” between the interest earned on loans, investment securities, and other interest-earning assets, and the interest paid on deposits, borrowings, and other interest-bearing liabilities. The interest rate risk inherent in our lending, investing, and deposit-taking activities is a material market risk to us and our business. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by fluctuations in interest rates. The magnitude and duration of changes in interest rates, events over which we have no control, may have an adverse effect on net interest income. The recent Federal Reserve's decision to lower the federal funds target rate may decrease our yields on loans and other interest earning assets. Prepayment and early withdrawal levels, which are also impacted by the decreases in interest rates, can materially affect our assets and liabilities. On the contrary, increases in interest rates may adversely affect the ability of our floating rate borrowers to meet their higher payment obligations, which could in turn lead to an increase in non-performing assets and net charge-offs.


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Generally, the interest rates on our interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent, or on the same basis. Even assets and liabilities with similar maturities or periods of re-pricing may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in general market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. Certain assets, such as adjustable rate loans, may have features such as floors that limit changes in interest rates on a short-term basis.
    
We seek to minimize the adverse effects of changes in interest rates by structuring our asset-liability composition to obtain the maximum spread. We use interest rate sensitivity analysis and a simulation model to assist us in managing asset-liability composition. However, such management tools have inherent limitations that may impair their effectiveness.

The replacement of LIBOR could adversely affect our revenue or expenses and the value of those assets or obligations.

LIBOR and certain other “benchmarks” are the subject of recent national, international, and other regulatory guidance and proposals for reform. These reforms may cause such benchmarks to perform differently than in the past or have other consequences which cannot be predicted. On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, publicly announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot be guaranteed after 2021. While there is no consensus on what rate or rates may become accepted alternatives to LIBOR, in May 2018 a group of selected large banks, the Alternative Reference Rate Committee or ARRC, and the Federal Reserve Bank of New York started to publish the Secured Overnight Finance Rate, or SOFR, as an alternative to LIBOR. SOFR is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, given the depth and robustness of the U.S. Treasury repurchase market. Furthermore, the Bank of England has commenced publication of a reformed Sterling Overnight Index Average or SONIA, comprised of a broader set of overnight Sterling money market transactions, as of April 23, 2018. The SONIA has been recommended as the alternative to Sterling LIBOR by the Working Group on Sterling Risk-Free Reference Rates. At this time, it is impossible to predict whether SOFR and SONIA will become accepted alternatives to LIBOR.

The market transition away from LIBOR to an alternative reference rate, including SOFR or SONIA, is complex and could have a range of adverse effects on our business, consolidated financial condition, and consolidated results of operations. In particular, any such transition could:

adversely affect the interest rates paid or received on, and the revenue and expenses associated with, our floating rate obligations, loans, deposits, derivatives, and other financial instruments tied to LIBOR rates, or other securities or financial arrangements given LIBOR’s role in determining market interest rates globally

adversely affect the value of our floating rate obligations, loans, deposits, and other financial instruments tied to LIBOR rates, or other securities or financial arrangements given LIBOR’s role in determining market interest rates globally

prompt inquiries or other actions from regulators in respect to our preparation and readiness for the replacement of LIBOR with an alternative reference rate

result in disputes, litigation, or other actions with counterparties regarding the interpretation and enforceability of certain fallback language in LIBOR-based securities

require the transition to or development of appropriate systems and analytics to effectively transition our risk management processes from LIBOR-based products to those based on the applicable alternative pricing benchmark, such as SOFR or reformed SONIA

Although the manner and impact of the transition from LIBOR to an alternative reference rate, as well as the effect of these developments on our funding costs, loan and investment and trading securities portfolios, asset-liability management, and business, is uncertain, because the Company does not have a material amount of LIBOR-based products and our credit documentation provides for the flexibility to move to alternative reference rates, our Management does not believe that the discontinuation of LIBOR will have any material adverse impact on the Company.

Disruptions in the real estate market could materially and adversely affect our business.

While overall the U.S. economy has experienced a prolonged low interest rate environment, the Southern California real estate market has recovered from what had been a substantial decline during the prior recession. On December 31, 2019, 43.3% and 18.1% of our total loans were comprised of commercial real estate and construction loans, respectively. Of the

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commercial real estate loans, 30.8% was non-owner-occupied. Because a significant portion of our loans are secured by real estate, any new downturn in the real estate market could materially and adversely affect our business. Our ability to recover on defaulted loans by selling the real estate collateral would then be diminished and we would likely experience greater exposure to risk of loss on loans.
The financial condition of other financial institutions could adversely affect us.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, and other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. Any such losses could have a material adverse effect on our consolidated financial condition and consolidated results of operations.

GENERAL BUSINESS RISKS

Our clients could move their money to alternative investments causing us to lose a lower cost source of funding.

Demand deposits can decrease when clients perceive alternative investments as providing a better risk/return tradeoff. Technology and other changes have made it more convenient for bank customers to transfer funds into alternative investments or other deposit accounts offered by other out-of-area financial institutions or non-bank service providers. Additionally, customers may withdraw deposits to utilize them to fund business expansion or equity investment. Moreover, should interest rates rise, this may impact our ability to maintain our current noninterest-bearing deposits percentage to total deposits (47.7% of total deposits at December 31, 2019). When clients move money out of Bank demand deposits, particularly noninterest-bearing deposits, we lose a relatively low cost source of funds, increasing our funding costs and reducing our net interest income.

Several rating agencies publish unsolicited ratings of the financial performance and relative financial health of many banks, including our Bank, based on publicly available data. As these ratings are publicly available, a decline in our ratings may result in deposit outflows or the inability of our Bank to raise deposits in the secondary market as broker-dealers and depositors may use such ratings in deciding where to deposit their funds.

Capital and liquidity standards recently adopted by U.S. banking regulators now require banks and bank holding companies to maintain more and higher quality capital and greater liquidity than has historically been the case.

New capital standards, both as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the new U.S. Basel III-based capital rules have had a significant effect on banks and bank holding companies. The new capital rules require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.

The need to maintain more and higher quality capital, as well as greater liquidity, going forward than historically has been required, and the increased regulatory scrutiny with respect to capital levels, could limit our business activities, including lending, and our ability to expand, either organically or through acquisitions. It could also result in being required to take steps to increase our regulatory capital that may be dilutive to shareholders or limit our ability to pay dividends or otherwise return capital to shareholders, or sell or refrain from acquiring assets, the capital requirements for which are not justified by the assets’ underlying risks.

Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.

From time to time, the Financial Accounting Standards Board (FASB) and SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our consolidated financial condition and consolidated results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in us restating prior period financial statements.

In June 2016, the FASB issued a new accounting standard for recognizing current expected credit losses, commonly referred to as CECL. CECL will result in earlier recognition of credit losses and requires consideration of not only past and current events but also reasonable and supportable forecasts that affect collectability. As a “smaller reporting company,” we will be required to comply with the new standard on January 1, 2023. Our implementation of CECL will likely affect our

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retained earnings, deferred tax assets and allowance for loan losses and, as a result, our regulatory capital ratios. In December 2018, the regulatory agencies approved a final rule that provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. CECL implementation poses operational risk, including the failure to properly transition internal processes or systems, which could lead to errors, financial misstatements, or operational losses.

We have liquidity risk.

Liquidity risk is the risk that we will have insufficient cash or access to cash to satisfy current and future financial obligations, including demands for loans and deposit withdrawals, funding operating costs, and for other corporate purposes. An inability to raise funds through deposits, borrowings, the sale of loans, and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. We mitigate liquidity risk by establishing and accessing lines of credit with various financial institutions and having back-up access to the brokered deposit markets. Results of operations could be affected if we were unable to satisfy current or future financial obligations. Please refer to Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.

Our controls and procedures could fail or be circumvented.

Our Management regularly reviews and updates our internal controls, disclosure controls, procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, but not absolute, assurances of the effectiveness of these systems and controls, and that the objectives of these controls have been met. Any failure or circumvention of our controls and procedures, and any failure to comply with regulations related to controls and procedures could adversely affect our business, and consolidated financial condition and consolidated results of operations.

The occurrence of fraudulent activity, breaches of our information security or cybersecurity-related incidents could have a material adverse effect on our business, consolidated financial condition or consolidated results of operations.

As a financial institution, we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our clients, denial or degradation of service attacks, and malware or other cyber-attacks. In recent periods, there continues to be a rise in electronic fraudulent activity, security breaches and cyber-attacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. We have also experienced an increase in malicious attempts, although, to our knowledge, none of these attempts have resulted in any material loss. Moreover, in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity. Some of our clients may have been affected by these breaches, which increase their risks of identity theft, credit card fraud and other fraudulent activity that could involve their accounts with us.

Information pertaining to us and our clients is maintained, and transactions are executed, on our networks and systems, and certain of our third-party partners, such as our online banking or reporting systems. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our clients against fraud and security breaches, and to maintain our clients’ confidence. Breaches of information security also may occur, and in infrequent cases have occurred, through intentional or unintentional acts by those having access to our systems or our clients’ or counterparties’ confidential information, including employees. Furthermore, our cardholders use their debit and commercial credit cards to make purchases from third parties or through third-party processing services. As such, we are subject to risk from data breaches of such third party’s information systems or their payment processors. Such a data security breach could compromise our account information. We may suffer losses associated with such fraudulent transactions, as well as for other costs related to data security breaches.
    

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In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third-party technologies (including browsers and operating systems), or other developments could result in a compromise or breach of the technology, processes, and controls that we use to prevent fraudulent transactions and to protect data about us, our clients, and underlying transactions, as well as the technology used by our clients to access our systems. Although we have developed, and continue to invest in, systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, our inability to anticipate, or failure to adequately mitigate, breaches of security could result in: losses to us or our clients; our loss of business and/or clients; damage to our reputation; the incurrence of additional expenses; disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability-any of which could have a material adverse effect on our business, consolidated financial condition, and consolidated results of operations.

More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions. Such publicity may also cause damage to our reputation as a financial institution. As a result, our business, consolidated financial condition, and consolidated results of operations could be adversely affected.

We could be liable for breaches of security in our online banking services. Fear of security breaches (including cybersecurity breaches) could limit the growth of our technology-driven products and services.

We offer various internet-based services to our clients, including mobile and online banking services either directly or through an arrangement with a service bureau or third party. The secure transmission of confidential information over the Internet is essential to maintain our clients’ confidence in our mobile and online services. In certain cases, we are responsible for protecting customers’ proprietary information as well as their accounts with us. We have security measures and processes in place to defend against these cybersecurity risks but these cyber-attacks are rapidly evolving (including computer viruses, malicious code, phishing or other information security breaches), and we may not be able to anticipate or prevent all such attacks, which could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information. Advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology we use to protect client transaction data. In addition, individuals, groups or sovereign countries may seek to intentionally disrupt our online banking services or compromise the confidentiality of customer information with criminal intent. Although we have developed systems and processes that are designed to recognize and assist in preventing security breaches (and periodically test our security), failure to protect against or mitigate breaches of security could adversely affect our ability to offer and grow our technology-driven products and services, constitute a breach of privacy or other laws, result in costly litigation and loss of customer relationships, negatively impact our reputation, and could have an adverse effect on our business, consolidated financial condition, and consolidated results of operations. The Company holds various insurance policies including cybersecurity insurance, however we may not be insured against all types of losses as a result of breaches and insurance coverage may be inadequate to cover all losses resulting from breaches of security. We may also incur substantial increases in costs in an effort to minimize or mitigate cyber security risks and to respond to cyber incidents.

Managing reputational risk is important to attracting and maintaining customers, investors, and employees.

Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality, compliance deficiencies, and questionable, illegal, or fraudulent activities of our customers. We have policies and procedures in place that seek to protect our reputation and promote ethical conduct, but these policies and procedures 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, costly litigation, a decline in revenues, and increased governmental regulation.

We rely on communications, information, operating, and financial control systems technology from third-party service providers.

We rely heavily on third-party service providers for much of our communications, information, operating, and financial control systems technology, including customer relationship management, internet banking, website, general ledger, deposit, loan servicing, and wire origination systems. Any failure, interruption, or breach in security of these systems could result in failures or interruptions in our customer relationship management, internet banking, website, general ledger, deposit, loan servicing, and/or wire origination systems. We cannot assure you that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. We may not be insured against all types of losses as a result of third-party failures and insurance coverage may be inadequate to cover all losses resulting from system failures or other disruptions. If any of our third-party service providers experience financial,

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operational, or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Any of these circumstances could have a material adverse effect on our business, consolidated financial condition, consolidated results of operations, and cash flows.

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. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber-attacks or security breaches of the networks, systems, or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our consolidated financial condition and consolidated results of operations.

We may experience losses related to fraud, theft, or violence.

We may experience losses incurred due to customer or employee fraud, theft, or physical violence. Additionally, physical violence may negatively affect our key personnel, facilities, or systems. These losses may be material and negatively affect our consolidated financial condition, consolidated results of operations, or prospects. These losses could also lead to significant reputational risks and other effects. The sophistication of external fraud actors continues to increase, and in some cases includes large criminal rings, which increases the resources and infrastructure needed to thwart these attacks. The industry fraud threat continues to evolve, including but not limited to card fraud, check fraud, social engineering, and phishing attacks for identity theft and account takeover. We continue to invest in fraud prevention in the forms of people and systems designed to prevent, detect, and mitigate the customer and financial impacts.

Our ability to attract and retain qualified employees is critical to our success.
 
Our employees are our most important resource. Competition for senior executives and skilled personnel in the banking industry is intense, which means the cost of hiring, incentivizing and retaining skilled personnel may continue to increase. We endeavor to attract talented and diverse new employees and retain and motivate our existing employees. Our senior management team has significant industry experience, and their knowledge and relationships would be difficult to replace. In addition, we continue to recruit qualified individuals to succeed existing key personnel to ensure the growth and successful operation of our business. If for any reason we are unable to continue to attract or retain qualified employees, our performance, including our competitive position, could be materially and adversely affected. In addition, to attract and retain personnel with appropriate skills and knowledge to support our business, we may offer a variety of benefits, which could reduce our earnings or have a material adverse effect on our business, financial condition or results of operations.

CREDIT RISKS

Deteriorating credit quality has adversely impacted us in the past and may adversely impact us in the future.

When we lend money or commit to lend money, we incur credit risk or the risk of loss if borrowers do not repay their loans or other credit obligations. The performance of these loan portfolios significantly affects our financial results and condition. If the current economic environment were to deteriorate, more customers may have difficulty in repaying their credit obligations, which could result in a higher level of loan losses and allowance for loan losses ("ALLL"). We reserve for loan losses by establishing reserves through a charge to earnings. The amount of these reserves is based on our assessment of loan losses inherent in the loan portfolios including unfunded credit commitments. The process for determining the amount of the ALLL, and the reserve for unfunded commitments is critical to our financial results and condition. It requires difficult, subjective, and complex judgments about the environment, including analysis of economic or market conditions that might impair the ability of our borrowers to repay their loans.

Our Management might underestimate the loan losses inherent in our portfolios and have loan losses in excess of the amount reserved. We might increase the reserve because of changing economic conditions, including falling home prices or higher unemployment, or other factors such as changes in borrower’s behavior or changing protections in credit agreements. As an example, borrowers may “strategically default,” or discontinue making payments on their real estate-secured loans if the value of the real estate is less than what they owe, even if they are still financially able to make the payments. We believe that both the ALLL and the reserve for unfunded commitments are adequate to cover incurred credit losses inherent in the loan portfolio and unfunded commitments at December 31, 2019; however, there is no assurance that they will be sufficient to cover future loan losses, especially if the commercial real estate market and employment conditions experience a decline. In the event of significant deterioration in economic conditions, we may be required to increase reserves in future periods,

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which would reduce earnings. For more information, refer to Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Potential Problem Loans.

Our allowance for loan loss may not be adequate to cover actual losses.

We maintain an ALLL on loans, which is a reserve established through a provision for loan losses charged to expense, that represents Management’s best estimate of risk of losses within the existing portfolio of loans. The level of the allowance reflects Management’s continuing evaluation of industry concentrations; specific credit risks; historical loan loss experience; current loan portfolio quality; present economic, political, and regulatory conditions, and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the ALLL inherently involves a high degree of subjectivity and requires our Management to make significant estimates of current credit risks and future trends, all of which may undergo material changes.

Deterioration in economic conditions affecting our borrowers and collateral, new information regarding existing loans, identification of problem loans and other factors, both within and outside of our control, may require an increase in the ALLL. In addition, bank regulatory agencies periodically review our ALLL and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of our Management. In addition, if charge-offs in future periods exceed the ALLL, we will need additional provisions to increase the ALLL. Any increases in the ALLL will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our consolidated financial condition and consolidated results of operations. Please refer to Part II, Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Allowance for Loan Loss for further discussion related to our process for determining the appropriate level of the ALLL.

We may suffer losses in our loan portfolio despite our underwriting practices.

We mitigate the risks inherent in our loan portfolio by adhering to sound and proven underwriting practices, managed by experienced and knowledgeable credit professionals. These practices include analysis of a borrower’s prior credit history, financial statements, tax returns, cash flow projections, valuations of collateral based on reports of independent appraisers, and verifications of liquid assets. Although we believe that our underwriting criteria is appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our ALLL.

Severe weather, natural disasters, or other climate change-related matters could significantly affect our business.
    
Our primary market is located in an earthquake-prone zone in Southern California, which is also subject to other weather or disasters, such as severe wildfire, earthquakes, drought, or flood. These events could unexpectedly interrupt our business operations. Climate-related physical changes and hazards could also pose credit risks for us. For example, some of our borrowers have collateral properties or operations located in coastal areas at risk to rising sea levels and erosion or subject to the risk of wildfires. The properties pledged as collateral on our loan portfolio could also be damaged by tsunamis, landslides, floods, earthquakes, or droughts, and thereby the recoverability of loans could be impaired. A number of factors can affect credit losses, including the extent of damage to the collateral, the extent of damage not covered by insurance, the extent to which unemployment and other economic conditions caused by the natural disaster adversely affect the ability of borrowers to repay their loans, and the cost of collection and foreclosure to us. Lastly, there could be increased insurance premiums and deductibles, or a decrease in the availability of coverage, due to severe weather-related losses. The ultimate outcome on our business of a natural disaster, whether or not caused by climate change, is difficult to predict.

We have a concentration in loans secured by commercial real estate which could make us vulnerable to changes in the commercial real estate market.

Our concentration in loans secured by commercial real estate (including owner-occupied nonresidential properties, other nonresidential properties, construction, land development and other land, and multifamily residential properties) has decreased slightly from 446% of total risk-based capital at December 31, 2018 to 441% of total risk-based capital at December 31, 2019. While our risk management practices are designed to closely monitor these loans as well as the market conditions, and analyze the impact of various stress scenarios on these loans, it is possible that an adverse change in the Southern California commercial real estate market could result in credit losses or the need to increase reserves or capital costs which could have a negative impact on our income, capital, prospects, or reputation.


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The repayment of our income property loans, consisting of non-owner occupied commercial real estate loans, may be dependent on factors outside our control or the control of our borrowers.

We originate non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties. Repayment of these loans is often dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions.
    
For example, if the cash flow from the borrower’s project is reduced as a result of the financial impairment of a lessee who cannot pay the rent, or as a result of leases not being obtained or renewed in a timely manner or at all, the borrower’s ability to repay the loan may be impaired. Non-owner occupied commercial real estate loans also expose us to greater credit risk than loans secured by residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our non-owner occupied commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either refinance or sell the underlying property in order to make the payment, which may increase the risk of default or non-payment.

If we foreclose on a non-owner occupied commercial real estate loan, our holding period for the collateral may be longer than for residential mortgage loans because there are fewer potential purchasers of the collateral and, therefore, our carrying cost for foreclosed non-owner occupied commercial real estate may be materially greater than for residential mortgage loans. Additionally, commercial real estate loans generally have relatively large balances to single borrowers or groups of related borrowers. Accordingly, if we make any errors in judgment in the collectability of our non-owner occupied commercial real estate loans, any resulting charge-offs may be larger on a per loan basis. As of December 31, 2019, our non-owner occupied commercial real estate loans totaled $423.8 million or 30.8% of our total loans held for investment, net of discounts.

Real estate construction loans are based upon estimates of costs and values associated with the completed project. These estimates may be inaccurate, and we may be exposed to significant losses on loans for these projects.
 
The risks inherent in real estate construction loans may adversely affect our business, consolidated financial condition, and consolidated results of operations. Such risks include, among other things, (i) the possibility that contractors may fail to complete, or complete on an untimely basis, construction of the relevant properties; (ii) substantial cost overruns in excess of original estimates and financing are incurred; (iii) market deterioration occurs during construction; and (iv) a lack of permanent take-out financing arises. Loans secured by such properties also involve additional risk because they have no operating history. The costs may exceed a project's realizable value in a declining real estate market and such properties may not be sold or leased so as to generate the cash flow anticipated by the borrower. Real estate construction loans, including land development loans, comprised approximately 18.1% of our total loan portfolio as of December 31, 2019.

Because of the uncertainties inherent in estimating construction costs and the realizable market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of the completed project proves to be overstated or market values or rental rates decline, we may have inadequate security for the repayment of the loan upon completion of construction of the project. If we are forced to foreclose on a project prior to or at completion due to a default, we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs. In addition, we may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time while we attempt to dispose of it. A general decline in real estate sales and prices across the United States or locally in the relevant real estate market, a decline in demand for commercial real estate loans, economic weakness, high rates of unemployment, and reduced availability of mortgage credit, are some of the factors that can adversely affect the borrowers’ ability to repay their obligations to us and the value of our security interest in collateral, and thereby adversely affect our business, consolidated financial condition, and consolidated results of operations.

Supervisory guidance on commercial real estate concentrations could restrict our activities and impose financial requirements or limits on the conduct of our business.

The Federal Regulatory Agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending intended to help ensure that institutions pursuing a significant commercial real estate lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities. There have been

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concerns about commercial real estate lending and underwriting expressed by the agencies along with historical concerns that rising commercial real estate loan concentrations may expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets. Existing guidance reinforces and enhances existing regulations and guidelines for safe and sound real estate lending by providing supervisory criteria, including numerical indicators to assist in identifying institutions with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny. The guidance does not limit banks’ commercial real estate lending, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. Our lending and risk management practices will be taken into account in supervisory evaluation of capital adequacy. The regulatory definition of a commercial real estate concentration excludes owner-occupied commercial real estate loans, but includes unsecured commercial and industrial loans for the purpose of real estate that are not secured by real estate. As of December 31, 2019, our commercial real estate concentration exceeded the regulatory guideline (as defined by the federal bank regulators) of 300% of total risk-based capital and exceeded 50% growth of our commercial real estate related loans over the past 36 months due primarily to the PCB acquisition. Our internal policy is to limit our commercial real estate concentration to 350% of total risk-based capital. Our commercial real estate concentration, as defined by regulatory guidance, was 314% of total risk-based capital at December 31, 2019, as compared to 309% at December 31, 2018. In addition, the federal bank regulators established a guideline of 100% of total risk-based capital for loans secured by commercial real estate construction and land development loans. Our internal policy is to limit these loans to 150% of total risk-based capital. At December 31, 2019 and 2018, total loans secured by commercial real estate under construction and land development represented 125% and 108% of total risk-based capital. If our risk management practices with regard to this portion of our portfolio are found to be deficient, it could result in increased reserves and capital costs or a need to reduce this type of lending which could negatively impact earnings.

Repayment of our commercial and industrial loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may not be sufficient to repay the loan in the event of default.

We make our commercial and industrial loans primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Collateral securing commercial and industrial loans are generally the working assets of a business that fluctuate in value, may depreciate over time, and could be difficult to appraise. For example, in the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrowers to collect the amounts due from their customers, and for loans secured by inventory, the sale or liquidation of the inventory may be dependent not only on the quality of the inventory but also on finding a willing buyer. As of December 31, 2019, our commercial and industrial loans totaled $309.0 million, or 22.5% of our total loans.

REGULATORY AND LEGAL RISKS

We are or may become involved from time to time in information-gathering requests, investigations and litigation, regulatory or other enforcement proceedings by various governmental regulatory agencies and law enforcement authorities, as well as self-regulatory agencies which may lead to adverse consequences.

We are or may become involved from time to time in information-gathering requests, reviews, investigations, and proceedings (both formal and informal) by governmental regulatory agencies and law enforcement authorities, as well as self-regulatory agencies, regarding our customers and businesses, as well as our sales practices, data security, product offerings, compensation practices, and other compliance issues. In addition, the complexity of the federal and state regulatory and enforcement regimes in the U.S. means that a single event or topic may give rise to numerous and overlapping investigations and regulatory proceedings which may result in material adverse consequences. These potential consequences include without limitation, adverse judgments, settlements, fines, penalties, injunctions or other actions, amendments and/or restatements of our SEC filings and/or financial statements, as applicable, and/or determinations of material weaknesses in our disclosure controls and procedures. In addition, responding to information-gathering requests, reviews, investigations, and proceedings, regardless of the ultimate outcome of the matter, could be time-consuming and expensive.

Like other financial institutions and companies, we are also subject to risk from potential employee misconduct, including non-compliance with policies and improper use or disclosure of confidential information. Substantial legal liability or significant regulatory or other enforcement action against our Company could materially adversely affect our business, consolidated financial condition, consolidated results of operations, and/or cause significant reputational harm to our business. The outcome of lawsuits and regulatory proceedings may be difficult to predict or estimate. Although we establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss. In addition, due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal proceedings, amounts accrued may not represent the ultimate loss from the legal proceedings in

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question. Thus, our ultimate losses may be higher, and possibly significantly so, than the amounts accrued for legal loss contingencies, which could adversely affect our results of operations.

The uncertain regulatory enforcement environment makes it difficult to estimate probable losses, which can lead to substantial disparities between legal reserves and actual settlements or penalties. For further information on specific legal and regulatory proceedings, please refer to Part I, Item 3 - Legal Proceedings.

Significant changes in banking laws or regulations and federal monetary policy could materially affect our business.

The banking industry is subject to extensive federal and state regulation, and significant new laws and regulations or changes in, or repeals of, existing laws and regulations may cause results to differ materially. Also, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects our credit conditions, primarily through open market operations in U.S. government securities, the discount rate for member bank borrowing, and bank reserve requirements. A material change in these conditions would affect our results. Federal and state regulatory agencies also frequently adopt changes to their regulations or change the manner in which existing regulations are applied. For further discussion of the regulation of financial services, please refer to Part I, Item 1 - Business - Regulation and Supervision.
  
We may incur fines, penalties, and other negative consequences from regulatory violations, which are possibly even inadvertent or unintentional violations.

We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations, but there can be no assurance that these will be effective. We may incur fines, penalties, and other negative consequences from regulatory violations. We may suffer other negative consequences resulting from findings of noncompliance with laws and regulations, which may also damage our reputation, and this in turn might materially affect our business and results of operations.

For example, the Bank Secrecy Act of 1970, the USA PATRIOT Act of 2001, and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. In addition, the Community Reinvestment Act, or CRA, imposes upon the Bank a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of our entire community, and requires our federal banking regulators to evaluate the Bank’s record in meeting the credit needs of our communities, including low- and moderate-income neighborhoods, and to take that record into account in their evaluation of certain regulatory applications, such as applications for mergers, consolidations and acquisitions or the Bank’s engagement in certain activities pursuant to the Gramm-Leach-Bliley Act (the “GLB”). An unsatisfactory rating may be the basis for denying such application. Accordingly, a determination that our policies, procedures and systems are deficient under the Bank Secrecy Act of 1970 or our record of meeting the credit needs of our entire community, including low and moderate income neighborhoods, is less than satisfactory could materially limit our ability to, or otherwise prevent us from, engaging in any expansion activities or any other activities contemplated in our strategic plan.

Further, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional, and even though systems and procedures designed to ensure compliance were in place at the time.

We are subject to privacy and data protection laws and regulations as well as contractual privacy and data protection obligations. Our failure to comply with these or any future laws, regulations, or obligations could subject us to sanctions and damages, and could harm our reputation and business.
 
We are subject to a variety of laws and regulations, including regulation by various federal government agencies and state and local agencies. We collect personally identifiable information and other data from our current and prospective customers in the course of offering and/or providing financial products, services, and our employees. Self-regulatory obligations, other industry standards, policies, and other legal obligations may apply to our collection, distribution, use, security, or storage of personally identifiable information or other data relating to individuals. These obligations may be interpreted and applied in an inconsistent manner from one jurisdiction to another and may conflict with one another, other regulatory requirements, or our internal practices. Any failure or perceived failure by us to comply with privacy or security laws, policies, industry standards, or legal obligations-or any security incident resulting in the unauthorized access to, or acquisition, release, or transfer of, personally identifiable information or other data relating to our customers, employees, and others may result in governmental enforcement actions, litigation, fines, and penalties or adverse publicity that could cause our customers to lose trust in us, which could have an adverse effect on our reputation and business.
 

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We expect there will continue to be new proposed laws, regulations, and industry standards concerning privacy, data protection, and information security. We cannot yet determine the impact such future laws, regulations, and standards may have on our business. In particular, California’s recently enacted privacy law (the “CCPA”) gives consumers significant rights over the use of their personal information and provides a private right of action for security breaches. Any new laws, regulations, other legal obligations or industry standards, or any changed interpretation of existing laws, regulations, or other standards may require us to incur additional costs and restrict our business operations. For example, many jurisdictions have enacted laws requiring companies to notify individuals of data security breaches involving certain types of personal data. These mandatory disclosures regarding a security breach could result in negative publicity to us, which may cause our customers to lose confidence in the effectiveness of our data security measures and could impact our operating results.

Liabilities from environmental regulations could materially and adversely affect our business and consolidated financial condition.

In the course of our business, we may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. The Bank may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of any contaminated site, we may be subject to common law claims by third parties based on damages, and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, consolidated financial condition, consolidated results of operations, and liquidity could be materially and adversely affected.

STRATEGY RISKS

Our growth will be inhibited if we cannot attract deposits and quality loans.

Our ability to increase our asset base depends in large part on our ability to attract additional deposits at favorable rates. We seek additional deposits by providing outstanding customer service and offering deposit products that are competitive with those offered by other financial institutions in our markets. In addition, our income depends in large part in attracting quality loan customers and loans in which to invest the deposits.

We have a continuing need to adapt to technological changes.

The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. The effective use of technology allows us to potentially serve our customers better, increase our operating efficiency by reducing operating costs, provide a wider range of products and services to our customers, and potentially attract new customers. Our future success will partially depend upon our ability to successfully leverage technology to provide products and services that will satisfy our customers’ demands for convenience, as well as to create additional operating efficiencies while still maintaining appropriate fraud and cyber-security controls. Our larger competitors already have existing infrastructures or substantially greater resources to invest in technological improvements. We generally arrange for such services through service bureau arrangements or other arrangements with third parties.

SBA lending is subject to government funding, which can be limited or uncertain.

The Bank engages in SBA lending through programs designed by the federal government to assist the small business community in obtaining financing from financial institutions that are given government guarantees as an incentive to make the loans. SBA lending is subject to federal legislation that can affect the availability and funding of the program. From time to time, this dependence on legislative funding causes limitations and uncertainties with regard to the continued funding of such programs, which could potentially have an adverse financial impact on our business.

We compete against larger banks and other institutions.

We face substantial competition for deposits and loans in our marketplace. Competition for deposits primarily comes from other commercial banks, savings institutions, thrift and loan associations, money market and mutual funds, and other investment alternatives. Competition for loans comes from other commercial banks, savings institutions, mortgage banking firms, thrift and loan associations, and other financial intermediaries. Our larger competitors, by virtue of their larger capital resources, have substantially greater lending limits than we have. They also provide certain services for their customers, including trust, wealth management, and international banking, which we only are able to offer indirectly through our

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correspondent relationships. In addition, they have greater resources and are able to offer longer maturities and on occasion, lower rates on fixed rate loans as well as more aggressive underwriting.

There is risk related to acquisitions.

We have engaged in expansion through the acquisitions of Pacific Commerce Bank in 2018 and may consider acquisitions in the future, subject to regulatory approval. We cannot predict the frequency, size, or timing of any future acquisitions, and we typically do not comment publicly on a possible acquisition until we have signed a definitive agreement. There can be no assurance that our future acquisitions, if any, will have the anticipated positive results.

There are risks associated with any such expansion, including, among others, incorrectly assessing the asset quality of a target, encountering greater than anticipated costs in integrating acquired businesses, facing resistance from customers or employees, being unable to profitably deploy assets acquired in the transaction, or litigation resulting from circumstances occurring at the acquired entity prior to the date of acquisition or resulting from the acquisition. Our earnings, consolidated financial condition, and prospects after a merger or acquisition depend in part on our ability to successfully integrate the operations of the acquired company. We may be unable to integrate operations successfully or to achieve expected cost savings. Any cost savings that are realized may be offset by losses in revenues or other charges to earnings.

Acquisitions involve inherent uncertainty and we cannot determine all potential events, facts, and circumstances that could result in loss or give assurances that our investigation or mitigation efforts will be sufficient to protect against any such loss.

Issuing additional shares of our common stock to acquire other banks and bank holding companies may result in dilution for existing shareholders and may adversely affect the market price of our stock.

In connection with our growth strategy, we have issued, and may issue in the future, shares of our common stock to acquire additional banks or bank holding companies that may complement our organizational structure. Resales of substantial amounts of common stock in the public market and the potential of such sales could adversely affect the prevailing market price of our common stock and impair our ability to raise additional capital through the sale of equity securities. We usually must pay an acquisition premium above the fair market value of acquired assets for the acquisition of banks or bank holding companies. Paying this acquisition premium, in addition to the dilutive effect of issuing additional shares, may also adversely affect the prevailing market price of our common stock.

Impairment of goodwill or amortizable intangible assets associated with acquisitions would result in a charge to earnings.

Goodwill is initially recorded at fair value and is not amortized, but is reviewed at least annually or more frequently if events or changes in circumstances indicate that the carrying value may not be fully recoverable. If our estimates of goodwill fair value change, we may determine that impairment charges are necessary. The Company evaluated goodwill for impairment and concluded there was no impairment at December 31, 2019 and 2018.

Our decisions regarding the fair value of assets acquired could be different than initially estimated, which could materially and adversely affect our business, consolidated financial condition, consolidated results of operations, and future prospects.

We acquired portfolios of loans in the Pacific Commerce Bank acquisition. Although these loans were marked to their estimated fair value pursuant to ASC Topic 805 Business Combinations, there is no assurance that the acquired loans will not suffer further deterioration in value resulting in charge-offs. The fluctuations in national, regional, and local economic conditions may increase the level of charge-offs in the loan portfolios that we acquired from Pacific Commerce Bank and correspondingly reduce our net income. These fluctuations are not predictable, cannot be controlled, and may have a material adverse impact on our operations and consolidated financial condition, even if other favorable events occur.

RISKS RELATED TO OUR STOCK

We are an “emerging growth company,” and any decision on our part to comply with certain reduced disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.
    
We are an “emerging growth company,” as defined in the JOBS Act and, for as long as we continue to be an emerging growth company, we may choose to take advantage of certain exemptions from various reporting requirements applicable to other public companies including, but not limited to: not being required to have our internal control over financial reporting audited by our independent registered public accounting firm pursuant to Section 404 of the Sarbanes-

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Oxley Act; reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements; and exemptions from the requirements to hold a nonbinding advisory vote on executive compensation and to obtain shareholder approval of any golden parachute payments not previously approved. To the extent we take advantage of any of these reduced reporting burdens in this Annual Report and future filings, the information that we provide our security holders may be different than you might get from other public companies in which you hold equity interests. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

Under Section 107(b) of the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have chosen to “opt out” of such extended transition period, however, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

Our accounting policies and processes are critical to how we report our consolidated financial condition and consolidated results of operations. They require Management to make estimates about matters that are uncertain.

Accounting policies and processes are fundamental to how we record and report our consolidated financial condition and consolidated results of operations. Some of these policies require use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Several of our accounting policies are critical because they require Management to make difficult, subjective, and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Pursuant to U.S. GAAP, we are required to make certain assumptions and estimates in preparing our financial statements, including the allowance for loan losses, valuation of acquired loans, the valuation of goodwill and core deposit intangible and the valuation of deferred tax assets, among other items. If assumptions or estimates underlying our financial statements are incorrect, we may experience material losses.

Management has identified certain accounting policies as being critical because they require Management’s judgment to ascertain the valuations of assets, liabilities, and contingencies. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, valuing an asset or liability, or recognizing or reducing a liability. We have established policies and control procedures that are intended to ensure these critical accounting estimates and judgments are controlled and applied consistently. Because of the uncertainty surrounding our judgments and the estimates pertaining to these matters, we cannot guarantee that we will not be required to adjust our accounting policies. Please refer to Part II, Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Summary of Critical Accounting Policies and Note 1 - Significant Accounting Policies to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data, of this Annual Report.

The price of our common stock may be volatile or may decline.

The trading price of our common stock may fluctuate widely as a result of a number of factors, many of which are outside our control. In addition, the stock market is subject to fluctuations in the share prices and trading volumes that affect the market prices of the shares of many companies. These broad market fluctuations could positively or adversely affect the market price of our common stock and may not be predictable. Among the factors that could affect our stock price, certain of which are beyond our control, are:

actual or anticipated quarterly fluctuations in our consolidated financial condition and consolidated results of operations

publication of research reports and recommendations by financial analysts

failure to meet analysts’ revenue or earnings estimates

failure to continue our common stock repurchase program

speculation in the press or investment community

strategic actions by us or our competitors, such as acquisitions or restructurings


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actions by institutional shareholders

fluctuations in the stock price and operating results of our competitors

general market conditions and, in particular, developments related to market conditions for the financial services industry

political events, elections, or changes in government or administration

proposed or adopted regulatory changes or developments

anticipated or pending investigations, proceedings, or litigation that involve or affect us

deletion from a well-known index

domestic and international economic factors unrelated to our performance

The stock market and, in particular, the market for financial institution stocks, may experience significant volatility based on its history. As a result, the market price of our common stock may change unpredictably. In addition, the trading volume in our common stock may fluctuate more than usual and cause significant price variations to occur. The trading price of the shares of our common stock and the value of our other securities will depend on many factors, which may change from time to time, including, without limitation, our consolidated financial condition, performance, creditworthiness and prospects, future sales of our equity or equity related securities, and other factors identified in the “Forward-Looking Statements.” A significant decline in our stock price could result in substantial losses for individual shareholders and could lead to costly and disruptive securities litigation.

There are also various regulatory restrictions on the ability of the Bank to pay dividends or make other payments to our holding company, in particular, federal and state banking laws regulate the amount of dividends that may be paid by the bank without prior approval.

The Dodd-Frank Act requires federal banking agencies to establish more stringent risk-based capital guidelines and leverage limits applicable to banks and bank holding companies. The final Basel III capital standards issued in 2013 by the Federal Reserve provide that distributions (including dividend payments and redemptions) on additional Tier 1 capital instruments may only be paid out of net income, retained earnings, or surplus related to other additional Tier 1 capital instruments. The final Basel III capital standards also introduced a new capital conservation buffer on top of the minimum risk-based capital ratios. Failure to maintain a capital conservation buffer above certain levels will result in restrictions on our ability to repurchase shares of our common stock, make dividend payments, redemptions, or other capital distributions. These requirements, and any other new regulations or capital distribution constraints, could adversely affect the ability of our Bank to pay dividends to our holding company and, in turn, affect our holding company’s ability to pay dividends on or repurchase our common stock. In addition, the Federal Reserve may also, as a supervisory matter, otherwise limit our holding company’s ability to pay dividends on our common stock.

Although we are electing to use the Community Bank Leverage Ratio, or CBLR, framework, beginning with our regulatory report to be filed for the first quarter of 2020, the minimum 9% leverage ratio used to assess compliance with the risk-based and leverage capital requirements in the generally applicable capital rules already incorporate a capital conservation buffer.  Accordingly, failure to maintain the minimum 9% leverage ratio under the CBLR framework will result in our Bank having to comply with the generally applicable capital rules, including the capital conservation buffer requirements thereof at which time, the failure to maintain this capital conservation buffer above certain levels will result in restrictions on our ability to make dividend payments and repurchases of our common stock.
 
In addition, our common stock may be fully subordinate to interests held by the U.S. government in the event of a receivership, insolvency, liquidation, or similar proceeding, including a proceeding under the “orderly liquidation authority” provisions of the Dodd-Frank Act.

We may be unable to, or choose not to, pay dividends on or repurchase our common stock.

Payment of stock or cash dividends on our common stock depends on a multitude of factors, including but not limited to: (a) our holding company may not have sufficient earnings since our primary source of income, the payment of dividends to it by our Bank, is subject to federal and state laws that limit the ability of our Bank to pay dividends; (b) Federal Reserve policy requires bank holding companies to pay cash dividends on common stock only out of net income available

33


over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and consolidated financial condition; or (c) our Board of Directors may determine that, even though funds are available for dividend payments, retaining the funds for internal uses, such as expansion of our operations, is a better strategy. If we fail to pay dividends, capital appreciation, if any, of our common stock may be the sole opportunity for gains on an investment in our common stock. In addition, in the event our Bank becomes unable to pay dividends to our holding company, our holding company may not be able to service our debt, pay our other obligations, continue repurchasing our common stock or pay dividends on our common stock. Accordingly, our holding company’s inability to receive dividends from our Bank could also have a material adverse effect on our business, consolidated financial condition, consolidated results of operations, and the value of our common stock.

Our stock trading volume may not provide adequate liquidity for investors.

Although shares of our common stock are listed for trading on The NASDAQ Capital Market, the average daily trading volume in the common stock varies and may be less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity, and orderliness depends on the presence in the marketplace of a sufficient number of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the daily average trading volume of our common stock, significant sales of the common stock in a brief period of time,-or the expectation of these sales-could cause a decline in the price of our common stock.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES
 
Our principal executive offices are located in Cerritos, California, and are leased by First Choice Bank. We lease all of our facilities and believe that if necessary, we could secure suitable alternative facilities on similar terms without adversely affecting operations. The following table provides certain information regarding the purpose and physical location of our offices at January 31, 2020.
Office
 
Address
 
Principal Executive Office
 
17785 Center Court Drive N., Suite 750, Cerritos, CA 90703
 
Branches:
 
 
 
Cerritos
 
12845 Towne Center Drive, Cerritos, CA 90703
 
Alhambra
 
407 W. Valley Blvd., Suite 1, Alhambra, CA 91803
 
Rowland Heights
 
17458 E. Colima Road, Rowland Heights, CA 91748
 
Anaheim
 
2401 E. Katella Ave., Suite 125, Anaheim, CA 92806
 
Carlsbad
 
5857 Owens Ave., Suite 106 Carlsbad, CA 92008
 
Los Angeles - 6th & Figueroa
 
888 W. 6th Street, Suite 550, Los Angeles, CA 90017
 
West Los Angeles
 
11300 West Olympic Blvd., Suite 100, Los Angeles, CA 90064
 
Chula Vista
 
530 Broadway, Chula Vista, CA 91910
 
Pasadena
 
918 E. Green Street, Suite 100, Pasadena, CA 91106
 
Loan production offices:
 
 
 
Manhattan Beach
 
2321 Rosecrans Ave., El Segundo, CA 90245
 
San Diego
 
12730 High Bluff Drive, Suite 100, San Diego, CA 92130
 


For information regarding our lease commitments, refer to Note 7 - Leases to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data, of this Annual Report.
 
ITEM 3. LEGAL PROCEEDINGS

We are from time to time engaged in various litigation matters including the defense of claims of improper or fraudulent loan practices or lending violations, and other matters, and we have a number of unresolved claims pending. In addition, as part of the ordinary course of business, we are parties to litigation involving claims to the ownership of funds in

34


particular accounts, the collection of delinquent accounts, challenges to security interests in collateral, and foreclosure interests that are incidental to our regular business activities. While the ultimate liability with respect to these other litigation matters and claims cannot be determined at this time, we believe that damages, if any, and other amounts relating to pending matters are not likely to be material to our consolidated financial position or results of operations, except as described above. Reserves are established for these various matters of litigation, when appropriate under ASC Topic 450 Contingencies, based in part upon the advice of legal counsel.
ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock began trading on the NASDAQ Capital Market (NASDAQ) under the symbol “FCBP” on May 1, 2018. Prior to that, our common stock was traded on the OTCQX® Best Market (“OTCQX”) under the symbol "FCBP".

Holders

As of March 2, 2020, the Company had 446 common stock shareholders of record based on the records of our transfer agent, and the closing price of the Company’s common stock was $22.96 per share.  The number of holders of record does not represent the actual number of beneficial owners of our common stock because securities dealers and others frequently hold shares in “street name” for the benefit of individual owners who have the right to vote shares.

Securities authorized for issuance under equity compensation plans

The following table provides information at December 31, 2019 with respect to securities outstanding and available under our 2013 Omnibus Stock Incentive Plan (“2013 Plan”), which is our only equity compensation plan:
Plan Category
Number of Securities to be Issued Upon Exercise of Outstanding Options and Awards
(a)
 
Weighted-Average Exercise Price of Outstanding Options and Awards
(b)
 
Number of Securities Remaining Available for Future Issuance (Excluding Securities Reflected in Column (a))
(c)
Equity compensation plans approved by security holders
 
 
 
 
313,671

Stock Options
137,531

 
$
10.20

 
 
Restricted Shares
113,635

 

 
 
 
251,166

 
$
5.59

 
313,671

Equity compensation plans not approved by security holders

 
$

 

Total
251,166

 
$
5.59

 
313,671


For further discussion of information required by this Item, please reference to Note 14 - Stock-Based Compensation to the Consolidated Financial Statements in Item 8 Financial Statements and Supplementary Data, of this Annual Report.

Unregistered Sales of Equity Securities
    
None.







35









Issuer Purchases of Equity Securities

The following table presents information relating to our repurchase of shares of common stock in the fourth quarter of 2019:
Period
(a) 
Total number of shares (or units) purchased (1)
 
(b) 
Average price paid per share (or unit)
 
(c) 
Total number of shares (or units) purchased as part of publicly announced plans or programs
 
(d) 
Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs (2)
October 1 – 31, 2019
2,362

 
$
21.65

 
1,744

 
745,703

November 1 – 30, 2019
2,700

 
$
22.80

 
2,700

 
743,003

December 1 – 31, 2019
9,103

 
$
22.97

 
9,103

 
733,900

Total
14,165

 
$
22.72

 
13,547

 
 
(1)
The total number of shares repurchased during the periods indicated includes shares purchased as part of a publicly announced stock purchase plan and shares withheld for income tax purposes in connection with the vesting of restricted stock awards. The shares were purchased or otherwise valued at the closing price of our common stock on the dates of purchase and/or withholding.

(2) An authorized stock repurchase plan providing for the repurchase of up to 1.2 million shares of our outstanding common stock, or approximately 10% of our then outstanding shares, was publicly announced on December 3, 2018. The repurchase program does not obligate us to purchase any particular number of shares.



36


ITEM 6. SELECTED FINANCIAL DATA

The following consolidated selected financial data is derived from the Company’s audited consolidated financial statements at and for the three years ended December 31, 2019. This information should be read in connection with our audited consolidated financial statements and accompanying notes included in Item 8 - Financial Statements and Supplementary Data, and Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Annual Report.
 
As of and for the Year Ended December 31,
 
2019
 
2018
 
2017
 
(dollars in thousands, except share data)
Results of Operations:
 
 
 
 
 
Interest income
$
90,354

 
$
64,377

 
$
40,819

Interest expense
12,092

 
8,710

 
6,041

Net interest income
78,262

 
55,667

 
34,778

Provision for loan losses
2,800

 
1,520

 
642

Net interest income after provision for loan losses
75,462

 
54,147

 
34,136

Noninterest income
7,700

 
3,610

 
5,061

Noninterest expense
43,240

 
36,192

 
23,754

Net income before taxes
39,922

 
21,565

 
15,443

Income taxes
12,074

 
6,435

 
8,089

Net income
$
27,848

 
$
15,130

 
$
7,354

 
 
 
 
 
 
Per Common Share Data:
 
 
 
 
 
Basic earnings per common share 1
$
2.38

 
$
1.66

 
$
1.02

Diluted earnings per common share 1
$
2.36

 
$
1.64

 
$
1.02

Cash dividends declared per common share
$
0.85

 
$
0.80

 
$
0.80

Book value per common share outstanding
$
22.50

 
$
21.16

 
$
14.56

Tangible book value per common share outstanding 2
$
15.70

 
$
14.33

 
$
14.56

Shares outstanding at period end
11,635,531

 
11,726,074

 
7,260,119

Weighted average shares outstanding - Basic
11,586,651

 
9,015,203

 
7,102,683

Weighted average shares outstanding - Diluted
11,687,089

 
9,143,242

 
7,138,404

 
 
 
 
 
 
Balance Sheet Data:
 
 
 
 
 
Investment securities, available-for-sale
$
26,653

 
$
29,543

 
$
32,460

Investment securities, held-to-maturity
5,056

 
5,322

 
5,300

Loans held for sale
7,659

 
28,022

 
10,599

Loans held for investment
1,374,675

 
1,250,981

 
741,713

Loans held for investment, net
1,361,153

 
1,239,925

 
731,216

Total assets
1,690,324

 
1,622,501

 
903,795

Noninterest-bearing deposits
626,569

 
546,713

 
235,584

Total deposits
1,313,693

 
1,252,339

 
772,679

Borrowings
90,000

 
104,998

 
20,000

Senior secured notes
9,600

 
8,450

 
350

Total shareholders’ equity
261,805

 
248,069

 
105,694

 
 
 
 
 
 
Performance Metrics:
 
 
 
 
 
Return on average assets
1.74
%
 
1.28
%
 
0.83
%
Return on average equity
10.93
%
 
9.09
%
 
6.96
%
Return on tangible equity 2
15.90
%
 
11.38
%
 
6.96
%

37


Yield on average earning assets
6.05
%
 
5.70
%
 
4.66
%
Cost of interest-bearing liabilities
1.61
%
 
1.32
%
 
1.05
%
Net interest margin
5.24
%
 
4.93
%
 
3.97
%
Dividend payout ratio
35.65
%
 
50.13
%
 
78.35
%
Equity to assets ratio
15.49
%
 
15.29
%
 
11.69
%
Loans to deposits ratio
104.64
%
 
99.89
%
 
95.99
%
Efficiency ratio 2
50.30
%
 
61.06
%
 
59.62
%
 
December 31,
 
2019
 
2018
 
2017
 
(dollars in thousands)
Credit Quality:
 
 
 
 
 
Loans 30-89 days past due 3
$
1,767

 
$
484

 
$
1,090

Loans 30-89 days past due 3 to total loans held for investment
0.13
%
 
0.04
%
 
0.15
%
Non-performing loans 3
$
11,265

 
$
1,722

 
$
1,761

Non-performing loans 3 to total loans held for investment
0.82
%
 
0.14
%
 
0.24
%
Non-performing assets 3
$
11,265

 
$
1,722

 
$
1,761

Non-performing assets 3 to total assets
0.67
%
 
0.11
%
 
0.19
%
Allowance for loan losses
$
13,522

 
$
11,056

 
$
10,497

Allowance for loan losses to total loans held for investment
0.98
%
 
0.88
%
 
1.42
%
Allowance for loan losses to non-performing loans 3
120.0
%
 
642.0
%
 
596.1
%
Net charge-offs
$
334

 
$
961

 
$
1,744

Net charge-offs to average loans
0.03
%
 
0.10
%
 
0.24
%
 
 
 
 
 
 
Regulatory Capital Ratios (First Choice Bank):
 
 
 
 
 
Tier 1 leverage ratio
12.01
%
 
12.03
%
 
11.75
%
Common equity Tier 1 capital
13.04
%
 
13.26
%
 
13.46
%
Tier 1 risk-based capital ratio
13.04
%
 
13.26
%
 
13.46
%
Total risk-based capital ratio
14.03
%
 
14.18
%
 
14.72
%
(1)
Basic and diluted earnings per share are based on the two-class method; net income available to common shareholders excludes dividends and earnings allocated to participating securities.
(2)
Refer to Non-GAAP Financial Measures in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Annual Report.
(3)
Amount excludes Purchased Credit Impaired ("PCI") loans.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of this management's discussion and analysis of financial condition and results of operations ("MD&A") is to focus on information about our consolidated financial condition at December 31, 2019 and 2018, and our consolidated results of operations for the two years ended December 31, 2019. Our consolidated financial statements and the supplemental financial data appearing elsewhere in this Annual Report should be read in conjunction with this discussion and analysis.

Overview

First Choice Bancorp, headquartered in Cerritos, California, is a California corporation that was incorporated on September 1, 2017 and is the registered bank holding company for First Choice Bank. Incorporated in March 2005 and commencing commercial bank operations in August 2005, First Choice Bank is a California-chartered member bank. References herein to “First Choice Bancorp,” “Bancorp,” or the “holding company,” refer to First Choice Bancorp on a standalone basis. The words “we,” “us,” “our,” or the “Company” refer to First Choice Bancorp and First Choice Bank collectively and on a consolidated basis. References to the “Bank” refer to First Choice Bank, on a stand-alone basis.


38


Headquartered in Cerritos, California, the Bank is a community-based financial institution that serves commercial and consumer clients in diverse communities. The Bank specializes in loans to small- to medium-sized businesses and private banking clients, commercial and industrial loans, and commercial real estate loans with a specialization in providing financial solutions for the hospitality industry. The Bank is a Preferred Small Business Administration (“SBA”) Lender. The Bank conducts business through nine full-service branches and two loan production offices located in Los Angeles, Orange and San Diego Counties.

As a California-chartered member bank, the Bank is primarily regulated by the California Department of Business Oversight (the “DBO”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank’s deposits are insured up to the maximum legal limit by the Federal Deposit Insurance Corporation (the “FDIC”) and, as a result, the FDIC also has examination authority over the Bank.

Effective July 31, 2018, we acquired Pacific Commerce Bancorp (“PCB”) and its wholly-own subsidiary bank, Pacific Commerce Bank by merger in an all-stock transaction. In connection therewith, we issued, in the aggregate, 4,386,816 shares of our common stock in exchange for all of the outstanding shares of PCB common stock and replacement stock options exercisable for 420,393 shares of our common stock in cancellation of PCB stock options. The acquisition has been accounted for using the acquisition method of accounting and, accordingly, the operating results of PCB have been included in the consolidated financial statements since August 1, 2018.

Recent Developments
 
Senior Secured Notes Maturity Date Extension

Effective December 22, 2019, we extended the maturity date of this line of credit to March 22, 2022. The interest rate decreased from Wall Street Journal Prime + 0.25%, floating to Wall Street Journal Prime, floating (effective January 2, 2020). At the same time, the debt covenants were updated and confirmed as follows (i) Bank leverage ratio greater than or equal to 9.0%, (ii) Bank Tier 1 capital ratio greater than or equal to 11.0% and $150.0 million, (iii) Bank total capital ratio greater than or equal to 12.0%, (iv) Bank CET1 capital ratio greater than or equal to 11.0%, (v) Bank trailing twelve months return on average assets, excluding one-time expense related to the merger with PCB, greater than or equal to 1.0%, (vi) Bank classified assets to Tier 1 capital plus the allowance for loan losses of less than or equal to 35.0%, (vii) certain defined Bank liquidity ratios and (viii) specific concentration levels for commercial real estate and construction and land development loans.

Downtown Branch Relocation and Consolidations
    
In December 2019, the Company (1) entered into an agreement to terminate the "Little Tokyo" office lease agreement and (2) relocated the downtown Los Angeles branch to a smaller space within the same building and signed a sublease of the current space which began on January 1, 2020. As a result of these relocation and consolidation efforts, the Company recognized an after-tax impairment charge of $568 thousand, or $0.05 per diluted share, in the fourth quarter of 2019. The year-to-date total impairment charge recognized for these two locations was $1.2 million pre-tax ($850 thousand after tax), which is estimated to result in net cost savings, after impairment charges, of approximately $621 thousand pre-tax ($437 thousand after tax). As a result of the impairment charges in 2019 and expected cost savings, occupancy expense for these locations is expected to be reduced on average by approximately $550 thousand before tax ($390 thousand after tax) annually over the next three years.
 
Stock Repurchase Plan

During the fourth quarter of 2019, the Company repurchased 13,547 shares of its common stock at an average price of $22.80 and a total cost of $309 thousand under the stock repurchase program announced in December 2018. For the year ended December 31, 2019, the Company repurchased 429,817 shares at an average price of $21.64 and a total cost of $9.3 million. The remaining number of shares authorized to be repurchased under this program was 733,900 shares at December 31, 2019.

Federal Reserve Bank Secured Borrowing Arrangement
    
In the third quarter of 2019, the Bank expanded its existing secured borrowing capacity with the Federal Reserve by participating in the Borrower-in-Custody ("BIC") program. As a result, our borrowing capacity with the Federal Reserve increased to $177.1 million at December 31, 2019. Prior to participating in the BIC program, the Bank only pledged securities held-to-maturity as collateral for access to the discount window. At December 31, 2019, the Bank has pledged certain qualifying loans with an unpaid principal balance of $252.4 million and securities held-to-maturity with a carrying

39


value of $5.1 million as collateral for this line of credit. Borrowings under this BIC program are overnight advances with interest chargeable at the Discount Window ("Primary Credit") borrowing rate. There were no borrowings under this arrangement at or during the years ended December 31, 2019 and 2018.

Financial Highlights

Financial Performance

Net income increased $12.7 million to $27.8 million or $2.36 per diluted share for 2019 compared to $15.1 million or $1.64 per diluted share for 2018. The increase in net income was driven by organic loan growth, increased yields on loans and the PCB acquisition which was completed on July 31, 2018. Our 2019 financial results include 12 months of PCB operations as compared to 5 months for 2018. In addition, our 2018 financial results included after-tax merger, integration and public company registration expenses of $4.0 million which reduced diluted earnings per share by $0.44 for 2018. There were no such expenses in 2019. Financial results for the full year of 2019 included after-tax impairment charges of $850 thousand, or $0.07 per diluted share, related to branch relocation and consolidation efforts that are expected to result in future cost savings.

Return on average assets and return on average equity was 1.74% and 10.93% for 2019 compared to 1.28% and 9.09% for 2018. The after-tax merger, integration and public company registration expenses lowered the return on average assets and return on average equity by 34 basis points and 242 basis points for 2018. Return on average tangible equity was 15.90% for 2019 compared to 11.38% for 2018. The after-tax merger, integration and public company registration expenses lowered the return on average tangible equity by 304 basis points for 2018. Refer to - Non-GAAP Financial Measures section in this MD&A.

Net interest margin increased 31 basis points to 5.24% for 2019 from 4.93% for 2018. The average cost of funds was 91 basis points for 2019 compared to 86 basis points for 2018. Average noninterest-bearing deposits represented 46.1% of average total deposits for 2019 compared to 35.9% for 2018.

Noninterest income increased $4.1 million due to a full year of PCB's operations included for 2019 versus only five months for 2018 and higher gain on sale of loans. The provision for loan losses increased $1.3 million due to organic loan growth and higher specific reserves. Noninterest expense increased $7.0 million due to higher expense in most of the overhead expense categories due to including PCB's operations since August 1, 2018 and impairment charges related to branch relocation and consolidations in 2019, offset by lower merger, integration and public company registration costs in 2019.

Our operating efficiency ratio was 50.3% in 2019 compared with 61.1% in 2018. Excluding the impact of the merger, integration and public company registration costs incurred in 2018, our operating efficiency ratio was 52.0% in 2018. Refer to - Non-GAAP Financial Measures section in this MD&A.

Balance Sheet Performance

Total consolidated assets increased $67.8 million to $1.69 billion at December 31, 2019 from $1.62 billion at December 31, 2018. Total loans held for investment increased $123.7 million, or 9.9%, to $1.37 billion at December 31, 2019 from $1.25 billion at December 31, 2018. Average loans during 2019 increased $331.8 million, or 33.7%, compared to 2018.

Total consolidated liabilities increased $54.1 million to $1.43 billion at December 31, 2019 from $1.37 billion at December 31, 2018. Total deposits increased $61.4 million to $1.31 billion at December 31, 2019 from $1.25 billion at December 31, 2018, offset by lower borrowings of $15.0 million. Senior secured notes increased $1.1 million to $9.6 million at December 31, 2019 from $8.5 million at December 31, 2018. Noninterest-bearing demand deposits totaled $626.6 million, or 47.7% of total deposits at December 31, 2019, compared to $546.7 million, or 43.7% of total deposits at December 31, 2018.

Total consolidated equity increased $13.7 million to $261.8 million at December 31, 2019 from $248.1 million at December 31, 2018 due primarily to net income of $27.8 million and the vesting and exercise of equity awards of $4.5 million, partially offset by stock repurchases of $9.4 million and cash dividends of $9.9 million. At December 31, 2019, tangible book value per share was $15.70 compared to $14.33 at December 31, 2018. Refer to - Non-GAAP Financial Measures section in this MD&A.


40


The Bank remained well-capitalized from a regulatory perspective. At December 31, 2019, the Bank had a total risk-based capital ratio of 14.03% and a Tier 1 common to risk weighted assets ratio of 13.04% compared to a total risk-based capital ratio of 14.18% and a Tier 1 common to risk weighted assets ratio of 13.26% at December 31, 2018.

Credit Quality

Non-performing assets increased to $11.3 million or 0.67% of total assets at December 31, 2019, compared to $1.7 million or 0.11% of total assets at December 31, 2018. The increase in nonperforming assets is due mostly to downgrading 16 SBA 7(a) loans totaling $6.0 million, three commercial real estate loans totaling $4.4 million and one commercial and industrial loan totaling $159 thousand, offset by charge-offs and payoffs totaling $917 thousand.

Primary Factors We Use to Evaluate Our Business
 
As a financial institution, we manage and evaluate various aspects of both our consolidated financial condition and consolidated results of operations. We evaluate the comparative levels and trends of the line items in our consolidated balance sheets and consolidated income statements and various financial ratios that are commonly used in our industry. We analyze these financial trends and ratios against our own historical performance, our budgeted performance and the consolidated financial condition and performance of comparable financial institutions in our region.
 
Segment Information
 
We provide a broad range of financial services to individuals and companies through our branch network. Those services include a wide range of deposit and lending products for businesses and individuals. While our chief decision makers monitor the revenue streams of our various product and service offerings, we manage our operations and review our financial performance on a company-wide basis. Accordingly, we consider all of our operations to be aggregated into one reportable operating segment.
 
Impact of Acquisition on Earnings

The comparability of our financial information is affected by the acquisition of PCB. We completed this acquisition on July 31, 2018. This acquisition has been accounted for using the acquisition method of accounting and, accordingly, PCB’s operating results have been included in the consolidated financial statements for periods beginning after July 31, 2018.

PCB was headquartered in Los Angeles, California, with $544.7 million in total assets, $414.9 million in gross loans and $474.8 million in total deposits as of July 31, 2018. PCB had six full-service branches in Los Angeles and San Diego Counties, including its operating division, ProAmérica Bank, in Downtown Los Angeles. The acquisition of PCB provided the Company with the opportunity to further serve our existing customers and to expand our footprint in Southern California to the Mexican border. Please refer to Note 2 - Business Combination to the Consolidated Financial Statements included in Item 8 Financial Statements and Supplementary Data, of this Annual Report.

Results of Operations
 
In addition to net income, the primary factors we use to evaluate and manage our results of operations include net interest income, noninterest income and noninterest expense.
 
Net Interest Income

Net interest income represents interest income less interest expense. We generate interest income from interest and fees (net of costs amortized over the expected life of the loans) plus the accretion of net discounts on interest-earning assets, including loans and investment securities and dividends on restricted stock investments. We incur interest expense from interest paid on interest-bearing liabilities, including interest-bearing deposits and borrowings. Net interest income has been the most significant contributor to our revenues and net income. To evaluate net interest income, we measure and monitor: (a) yields and accretable net discount on our loans and other interest-earning assets; (b) the costs of our deposits and other funding sources; and (c) our net interest margin. Net interest margin is calculated as the annualized net interest income divided by average interest-earning assets. Because noninterest-bearing sources of funds, such as noninterest-bearing deposits and shareholders’ equity, also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing sources.
 

41


Changes in market interest rates, the slope of the yield curve, and interest we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities, usually have the largest impact on changes in our net interest spread, net interest margin and net interest income during a reporting period.
 
Noninterest Income

Noninterest income consists of, among other things: (a) gain on sale of loans; (b) service charges and fees on deposit accounts; (c) net servicing fees; and (d) other noninterest income. Gain on sale of loans includes origination fees, capitalized servicing rights and other related income. Net loan servicing fees are collected as payments are received for loans in the servicing portfolio and offset by the amortization expense of the related servicing asset; this revenue stream is impacted by loan prepayments.
 
Noninterest Expense

    Noninterest expense includes: (a) salaries and employee benefits; (b) occupancy and equipment; (c) data processing; (d) professional fees; (e) office, postage and telecommunication; (f) deposit insurance and regulatory assessments; (g) loan related expenses; (h) customer service related expenses; (i) merger, integration and public company registration expenses; (j) amortization of core deposit intangible; and (k) other general and administrative expenses. 

Financial Condition
 
The primary factors we use to evaluate and manage our consolidated financial condition are asset levels, liquidity, capital and asset quality.
 
Asset Levels

We manage our asset levels based upon forecasted loan originations and estimated loan sales to ensure we have both the necessary liquidity and capital to fund asset growth while exceeding the required regulatory capital ratios. We evaluate our funding needs by forecasting loan originations and sales of loans.
 
Liquidity

We manage our liquidity based upon factors that include the amount of our custodial and brokered deposits as a percentage of total assets and deposits, the level of diversification of our funding sources, the allocation and amount of our deposits among deposit types, the short-term funding sources used to fund assets, the amount of non-deposit funding used to fund assets, the availability of unused funding sources, off-balance sheet obligations, the availability of assets to be readily converted into cash without a material loss on the investment, the amount of cash and cash equivalent securities we hold, the repricing characteristics and maturities of our assets when compared to the repricing characteristics of our liabilities and other factors.

Capital

We manage our regulatory capital based upon factors that include: (a) the level of capital and our overall consolidated financial condition; (b) the trend and volume of problem assets; (c) the level and quality of earnings; (d) the risk exposures and level of reserves in our consolidated balance sheets; and (e) other factors. In addition, we have regularly increased our capital through equity issuances and net income and we return capital to our shareholders through dividends and share repurchases.

Asset Quality
    
We manage the diversification and quality of our assets based upon factors that include the level, distribution, severity and trend of problem, classified, delinquent, nonaccrual, nonperforming and restructured assets, the adequacy of our allowance for loan losses, the diversification and quality of loan and investment portfolios, the extent of counterparty risks, credit risk concentrations and other factors.
 
Non-GAAP Financial Measures
 
This following tables present a reconciliation of non-GAAP financial measures to GAAP measures for: (1) efficiency ratio, (2) adjusted efficiency ratio, (3) adjusted net income, (4) average tangible common equity, (5) adjusted return

42


on average assets, (6) adjusted return on average equity, (7) return on average tangible common equity, (8) adjusted return on average tangible common equity, (9) tangible common equity, (10) tangible assets, (11) tangible common equity to tangible asset ratio, and (12) tangible book value per share. The Company believes the presentation of certain non-GAAP financial measures assists investors in evaluating our financial results. These non-GAAP financial measures are used by management, the Board and investors on a regular basis, in addition to our GAAP results, to facilitate the assessment of our financial performance. These non-GAAP financial measures complement our GAAP reporting and are presented below to provide investors and others information that we use to manage the business each period. Because not all companies use identical calculations, the presentation of these non-GAAP financial measures may not be comparable to other similarly titled measures used by other companies. However, we believe the non-GAAP information shown below provides useful information to investors to assess our consolidated financial condition and consolidated results of operations. In particular, the use of return on average tangible equity, tangible equity to asset ratio, and tangible book value per share is prevalent among banking regulators, investors and analysts. These non-GAAP measures should be taken together with the corresponding GAAP measures and should not be considered a substitute of the GAAP measures.
 
Year Ended December 31,
 
2019
 
2018
Efficiency Ratio
(dollars in thousands)
Noninterest expense (numerator)
$
43,240

 
$
36,192

Less: Merger, integration and public company registration costs

 
5,385

Adjusted noninterest expense (numerator)
$
43,240

 
$
30,807

 
 
 
 
Net interest income (denominator)
$
78,262

 
$
55,667

Plus: Noninterest income
7,700

 
3,610

Total net interest income and noninterest income (denominator)
$
85,962

 
$
59,277

 
 
 
 
Efficiency ratio (1)
50.3
%
 
61.1
%
Adjusted efficiency Ratio (1)
50.3
%
 
52.0
%
(1) Non-GAAP measure.
 
Year Ended December 31,
 
2019
 
2018
Return on Average Assets, Equity, Tangible Common Equity

(dollars in thousands)
Net income
$
27,848

 
$
15,130

Add: After-tax merger, integration and public company registration costs

 
4,029

Adjusted net income (1)
$
27,848

 
$
19,159

Average assets

1,603,600

 
1,184,309

Average shareholders’ equity
254,770

 
166,474

Less: Average intangible assets
79,631

 
33,575

Average tangible equity (1)
$
175,139

 
$
132,899

 
 
 
 
Return on average assets

1.74
%
 
1.28
%
Adjusted return on average assets (1)

1.74
%
 
1.62
%
Return on average equity
10.93
%
 
9.09
%
Adjusted return on average equity (1)

10.93
%
 
11.51
%
Return on average tangible common equity (1)
15.90
%
 
11.38
%
Adjusted return on average tangible common equity (1)

15.90
%
 
14.42
%
(1) Non-GAAP measure.


43


 
December 31,
 
2019
 
2018
Tangible Common Equity Ratio/Tangible Book Value Per Share
(dollars in thousands)
Shareholders’ equity
$
261,805

 
$
248,069

Less: Intangible assets
79,153

 
80,001

Tangible common equity (1)
$
182,652

 
$
168,068

 
 
 
 
Total assets
$
1,690,324

 
$
1,622,501

Less: Intangible assets
79,153

 
80,001

Tangible assets  (1)
$
1,611,171

 
$
1,542,500

 
 
 
 
Equity to asset ratio
15.49
%
 
15.29
%
Tangible common equity to tangible asset ratio  (1)
11.34
%
 
10.90
%
Book value per share
$
22.50

 
$
21.16

Tangible book value per share  (1)
$
15.70

 
$
14.33

Shares outstanding
11,635,531

 
11,726,074

(1) Non-GAAP measure.

Comparison of Operating Results
 
General

Net income was $27.8 million or $2.36 diluted earnings per share for 2019 compared to $15.1 million or $1.64 diluted earnings per share for 2018. The $12.7 million increase in net income was due to higher net interest income of $22.6 million and noninterest income of $4.1 million, partially offset by increases in provision for loan losses of $1.3 million, noninterest expense of $7.0 million and income taxes of $5.6 million for 2019 compared to 2018. The increase in net interest income was a result of higher average loan balances, relating to both the PCB acquisition and organic loan growth, and increased yields on loans. Noninterest income increased due to higher SBA loan sale activity and related gains, as well as higher service charges and fees on deposits accounts. We also had increases in servicing fees and other income. Noninterest expense increased due primarily to higher salaries and employee benefits, occupancy and equipment costs, data processing expenses, customer service related costs and CDI amortization, largely due to the impact of including PCB's operations for the full 2019 fiscal year and the impairment charges related to branch relocation and consolidations, offset by lower merger, integration and public company registration expenses.
























44


Net Interest Income

Net interest income is affected by changes in both interest rates and the volume of average interest-earning assets and interest-bearing liabilities. The following table summarizes the distribution of average assets, liabilities and stockholders’ equity, as well as interest income and yields earned on average interest-earning assets and interest expense and rates paid on average interest-bearing liabilities for the periods indicated:

 
Year Ended December 31,
 
2019
 
2018
 
2017
 
Average
Balance
 
Interest
Income / Expense
 
Yield / Cost
 
Average
Balance
 
Interest
Income / Expense
 
Yield / Cost
 
Average
Balance
 
Interest
Income / Expense
 
Yield / Cost
Interest-earning assets:
(dollars in thousands)
Loans (1)
$
1,317,345

 
$
86,207

 
6.54
%
 
$
985,513

 
$
61,075

 
6.20
%
 
$
739,935

 
$
38,624

 
5.22
%
Investment securities
35,883

 
853

 
2.38
%
 
37,642

 
922

 
2.45
%
 
42,456

 
959

 
2.26
%
Deposits in other financial institutions
124,506

 
2,375

 
1.91
%
 
98,353

 
1,847

 
1.88
%
 
87,087

 
935

 
1.07
%
Federal funds sold/resale agreements
1,243

 
30

 
2.41
%
 
1,258

 
25

 
1.99
%
 
2,221

 
35

 
1.58
%
Restricted stock investments and other bank stocks
13,973

 
889

 
6.36
%
 
7,043

 
508

 
7.21
%
 
3,881

 
266

 
6.86
%
Total interest-earning assets
1,492,950

 
90,354

 
6.05
%
 
1,129,809

 
64,377

 
5.70
%
 
875,580

 
40,819

 
4.66
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-earning assets
110,650

 
 
 
 
 
54,500

 
 
 
 
 
8,850

 
 
 
 
Total assets
$
1,603,600

 
 
 
 
 
$
1,184,309

 
 
 
 
 
$
884,430

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest checking
$
120,494

 
$
1,268

 
1.05
%
 
$
153,403

 
$
1,679

 
1.09
%
 
$
243,568

 
$
2,631

 
1.08
%
Money market accounts
278,075

 
3,498

 
1.26
%
 
196,871

 
2,275

 
1.16
%
 
73,734

 
483

 
0.66
%
Savings accounts
30,608

 
232

 
0.76
%
 
51,254

 
410

 
0.80
%
 
85,315

 
797

 
0.93
%
Time deposits
149,921

 
2,647

 
1.77
%
 
176,761

 
2,912

 
1.65
%
 
107,606

 
1,242

 
1.15
%
Brokered time deposits
107,958

 
2,626

 
2.43
%
 
52,879

 
774

 
1.46
%
 
44,125

 
648

 
1.47
%
Total interest-bearing deposits
687,056

 
10,271

 
1.49
%
 
631,168

 
8,050

 
1.28
%
 
554,348

 
5,801

 
1.05
%
Borrowings
49,914

 
1,143

 
2.29
%
 
23,176

 
412

 
1.78
%
 
20,475

 
239

 
1.16
%
Senior secured notes
11,933

 
678

 
5.68
%
 
4,544

 
248

 
5.46
%
 
3

 
1

 
%
Total interest-bearing liabilities
748,903

 
12,092

 
1.61
%
 
658,888

 
8,710

 
1.32
%
 
574,826

 
6,041

 
1.05
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
586,508

 
 
 
 
 
353,157

 
 
 
 
 
199,766

 
 
 
 
Other liabilities
13,419

 
 
 
 
 
5,790

 
 
 
 
 
4,206

 
 
 
 
Shareholders’ equity
254,770

 
 
 
 
 
166,474

 
 
 
 
 
105,632

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and shareholders' equity
$
1,603,600

 
 
 
 
 
$
1,184,309

 
 
 
 
 
$
884,430

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread
 
 
$
78,262

 
4.44
%
 
 
 
$
55,667

 
4.38
%
 
 
 
$
34,778

 
3.61
%
Net interest margin
 
 
 
 
5.24
%
 
 
 
 
 
4.93
%
 
 
 
 
 
3.97
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total deposits
$
1,273,564

 
$
10,271

 
0.81
%
 
$
984,325

 
$
8,050

 
0.82
%
 
$
754,114

 
$
5,801

 
0.77
%
Total funding sources
$
1,335,411

 
$
12,092

 
0.91
%
 
$
1,012,045

 
$
8,710

 
0.86
%
 
$
774,592

 
$
6,041

 
0.78
%
(1)
Average loans include net discounts and net deferred loan fees and costs. Interest income on loans includes $958 thousand, $469 thousand and $439 thousand related to the accretion of net deferred loan fees during 2019, 2018 and 2017. In addition, interest income includes $4.6 million and $2.2 million of discount accretion on loans acquired in a business combination, including the interest recognized on the payoff of PCI loans, during December 31, 2019 and 2018. There was no discount accretion on loans acquired in a business combination during 2017.

Rate/Volume Analysis

The volume and interest rate variances table below sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such

45


change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in the average balance times the prior period rate, and rate variances are equal to the increase or decrease in the average rate times the prior period average balance. Variances attributable to both rate and volume changes are allocated proportionately based on the amounts of the individual rate and volume changes.
 
 
Year Ended December 31,
 
2019 vs. 2018
 
2018 vs. 2017
 
Change Attributable to
 
 
 
Change Attributable to
 
 
 
Volume
 
Rate
 
Total Change
 
Volume
 
Rate
 
Total Change
Interest and dividend income:
(dollars in thousands)
Interest and fees on loans
$
21,612

 
$
3,520

 
$
25,132

 
$
14,340

 
$
8,111

 
$
22,451

Interest on investment securities
(40
)
 
(29
)
 
(69
)
 
(107
)
 
70

 
(37
)
Dividends on restricted stock investments and other bank stocks
448

 
(67
)
 
381

 
227

 
15

 
242

Interest on deposits in financial institutions and fed funds sold
498

 
35

 
533

 
115

 
787

 
902

Change in interest and dividend income
22,518

 
3,459

 
25,977

 
14,575

 
8,983

 
23,558

 
 
 
 
 
 
 
 
 
 
 
 
Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Savings, interest checking and money market accounts
502

 
132

 
634

 
(45
)
 
498

 
453

Time deposits
665

 
922

 
1,587

 
1,127

 
669

 
1,796

Borrowings
584

 
147

 
731

 
38

 
134

 
172

Senior secured notes
420

 
10

 
430

 
249

 
(1
)
 
248

Change in interest expense
2,171

 
1,211

 
3,382

 
1,369

 
1,300

 
2,669

 
 
 
 
 
 
 

 

 

Change in net interest income
$
20,347

 
$
2,248

 
$
22,595

 
$
13,206

 
$
7,683

 
$
20,889


Net interest income was $78.3 million during 2019, an increase of $22.6 million from $55.7 million during 2018 due to higher interest and dividend income of $26.0 million partially offset by higher interest expense of $3.4 million. The increase in interest income was due mostly to higher accelerated discount accretion from loans acquired in a business combination, including the payoff of PCI loans of $2.3 million, higher average interest-earning assets of $363.1 million due to assets acquired in the PCB acquisition, organic loan growth and higher average market interest rates during 2019. Average loan balances increased $331.8 million to $1.32 billion during 2019 compared to $985.5 million for the same 2018 period. The average effective federal funds target rate was 2.16% during 2019 compared to 1.83% for the same 2018 period. The PCB acquisition added $399.8 million in net loans at the time of acquisition.

Net interest margin increased 31 basis points to 5.24% for the year ended December 31, 2019 compared to 4.93% for the same 2018 period. The increase in the net interest margin was due primarily to a 34 basis point increase in loan yields, including fees and discounts, and a 7 basis point increase in other interest-earning assets yield, offset partially by a 5 basis
point increase in funding costs. The increase in the interest-earning assets yield and loan yield were driven by higher market rates on new loan production and loan repricing through the first half of 2019, and higher discount accretion from loans acquired in a business combination, including the payoff of PCI loans. This discount accretion increased our net interest margin and loan yield by 31 basis points and 35 basis points for 2019 compared to 20 basis points and 23 basis points for 2018.

The cost of funds increased to 0.91% for 2019, compared to 0.86% for 2018 as a result of an increase in the cost of interest-bearing liabilities due to higher market interest rates in the first half of 2019, offset by an improved funding mix from the PCB acquisition. Average interest-bearing deposits increased $55.9 million to $687.1 million and the cost of such deposits increased 21 basis points to 1.49%. Average borrowings and senior secured notes increased $34.1 million to $61.9 million and the cost of such funds increased 45 basis points to 2.94%. Average noninterest-bearing demand deposits increased $233.4 million to $586.5 million and represented 46.1% of total average deposits for 2019, compared to $353.2 million, or 35.9% of total average deposits, for 2018. The total cost of deposits decreased 1 basis points to 0.81% for 2019, compared to 0.82% for 2018.
 


46


Provision for Loan Losses

We maintain an allowance for loan losses at a level we believe is adequate to absorb probable incurred credit losses. The allowance for loan losses is estimated using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. At December 31, 2019, the allowance for loan losses was $13.5 million, or 0.98% of loans held for investment compared to $11.1 million, or 0.88% of loans held for investment at December 31, 2018. The increase in the allowance for loan losses for 2019 results primarily from loan growth and higher specific reserves for nonaccrual loans primarily from three lending relationships. The net carrying value of loans acquired through the acquisition of PCB, excluding PCI loans, totaled $248.0 million and included a remaining net discount of $6.0 million at December 31, 2019, which represented 2.41% of the net carrying value of acquired loans and 0.43% of total gross loans held for investment.
 
The provision for loan losses totaled $2.8 million during 2019 compared to $1.5 million during 2018. The increase in provision for loan losses was primarily the result of organic loan growth, coupled with an increase in specific reserves of $1.2 million, the majority of which related to three lending relationships.
 
Noninterest Income

The following table shows the components of noninterest income between periods:
 
Year Ended December 31,
 
2019
 
2018
 
(dollars in thousands)
Gain on sale of loans
$
3,674

 
$
1,505

Service charges and fees on deposit accounts
1,942

 
1,241

Net servicing fees
850

 
509

Other income
1,234

 
355

Total noninterest income
$
7,700

 
$
3,610


Noninterest income increased $4.1 million to $7.7 million during 2019 compared to $3.6 million during 2018 primarily due to higher net earnings for all of the categories as a result of including PCB's operation since the acquisition date and higher gain on the sale of loans of $2.2 million. The 2019 loan sales related to 51 SBA loans with a net carrying value of $61.6 million at an average premium of 6.0%, resulting in a gain of $3.7 million and three commercial and industrial loans with the net carrying value of $2.3 million, resulting in a gain of $1 thousand during 2019. This compares to 31 SBA loans sold with a net carrying value of $25.0 million at an average premium percentage of 6.0%, resulting in a gain of $1.5 million for the 2018 period.
 
Services charges and fees on deposit accounts increased $701 thousand to $1.9 million during 2019 from $1.2 million for the comparable 2018 period. The increase was attributed to a higher volume of transaction-based accounts and account balances as a result of organic growth and the PCB acquisition. Average demand deposit account balances increased to $586.5 million during 2019 from $353.2 million for the comparable 2018 period.

Net servicing fees increased $341 thousand to $850 thousand during 2019 from $509 thousand for the comparable 2018 period. The increase was due primarily to higher servicing fee income, offset with higher amortization expense of the related servicing asset during 2019. During 2019 and 2018, contractually-specified servicing fees were $2.0 million and $1.5 million. Offsetting these servicing fees was amortization of $1.1 million during 2019 and $1.0 million during 2018. The amortization expense for 2019 included a $146 thousand acceleration of amortization expense that resulted from increased prepayment speeds on the related SBA loans. Our average SBA loan servicing portfolio was $208.6 million for 2019 compared to $164.2 million for 2018. The increase in our average SBA loan servicing portfolio primarily related to the acquisition of PCB in 2018 which contributed $73.8 million to the portfolio of serviced SBA loans, coupled with the higher volume of loan sales servicing retained during 2019.

Other income increased $879 thousand to $1.2 million during 2019 from $355 thousand for the comparable 2018 period. The increase was attributed primarily to: (i) higher net realized gains on equity securities with a readily determinable fair value of $202 thousand; and (ii) two CDFI Bank Enterprise Awards totaling $466 thousand for which there was no similar income in the same 2018 period. We recognized two Bank Enterprise Awards in 2019 as these awards were granted in 2018 for use and recognition during 2019; one award was granted to PCB prior to its acquisition date in 2018 and the other award was granted to First Choice Bank.


47


Noninterest Expense

The following table shows the components of noninterest expense between periods:
 
Year Ended December 31,
 
2019
 
2018
 
(dollars in thousands)
Salaries and employee benefits
$
25,691

 
$
18,077

Occupancy and equipment
5,406

 
3,049

Data processing
2,864

 
2,293

Professional fees
1,633

 
1,598

Office, postage and telecommunications
1,032

 
938

Deposit insurance and regulatory assessments
392

 
460

Loan related
694

 
483

Customer service related
1,755

 
865

Merger, integration and public company registration costs

 
5,385

Amortization of core deposit intangible
848

 
332

Other expenses
2,925

 
2,712

Total noninterest expense
$
43,240

 
$
36,192

 
Noninterest expense increased $7.0 million to $43.2 million during 2019 from $36.2 million for 2018. The increase in most of the overhead expense categories was due to including PCB's operations for a full fiscal year in 2019, compared to just five months during 2018, impairment charges related to branch relocation and consolidations of $1.2 million in 2019 and the increase in customer service related expenses from higher average demand deposits, offset by the decrease of $5.4 million in merger, integration and public company registration costs.

The $7.6 million increase in salaries and employee benefits was primarily due to: (i) the growth in headcount from former PCB employees retained subsequent to the acquisition. The average FTE employees for 2019 was 180 compared to 136 FTE employees for the same 2018 period; (ii) annual merit increase in the normal course of business; (iii) higher temporary and overtime costs; and (iv) higher commission from loan and deposit growth.
 
The $2.4 million increase in occupancy and equipment costs was due to the branches added in the PCB acquisition and impairment charges for the right-of-use ("ROU") asset and fixed assets relating to the relocation of our downtown Los Angeles branch and the early termination of the lease for our former Little Tokyo branch. The total impairment charge recognized for these two locations was $1.2 million, which is estimated to result in net cost savings, after impairment charges, of approximately $621 thousand before tax ($437 thousand after tax).

The $571 thousand increase in data processing primarily related to increases in transaction volume from both organic growth and the PCB acquisition, enhancing automation and delivering risk mitigation solutions to improve our customers’ banking experience. 

The $890 thousand increase in customer service related expenses was primarily due to higher average noninterest-bearing demand deposits between periods. Average noninterest-bearing demand deposits totaled $586.5 million for 2019 compared to $353.2 million for 2018.

In connection with the PCB acquisition and completion of a S-4 registration statement in 2018, we recognized $5.4 million in merger, integration and public company registration costs, which included $1.8 million in severance costs, $768 thousand in professional fees, $2.5 million in system integration costs, and $414 thousand in other expenses. There were no similar merger related costs in 2019.

The $516 thousand increase in the amortization of core deposit intangible (CDI) was a result of including amortization expense for the full fiscal year of 2019 compared to just five months of amortization during 2018, coupled with accelerated amortization of CDI in 2019.


48


Income Taxes

Income tax expense was $12.1 million during 2019, compared to $6.4 million for 2018. The effective tax rate for 2019 was 30.2% compared to 29.8% for 2018. The difference in our effective tax rate compared to the statutory rate of 29.6% for the respective reporting periods was primarily attributable to the impact of the vesting and exercise of equity awards combined with changes in the Company's stock price over time.